The Bull Case

“Know the enemy and know yourself; in a hundred battles you will never be in peril. When you are ignorant of the enemy, but know yourself, your chances of winning or losing are equal. If ignorant both of your enemy and yourself, you are certain in every battle to be in peril.”   — Sun Tzu (Chinese military strategist, "The Art of War," circa 6th century B.C.)


The Stock Trader's Almanac laid out the Bull's case last week:  Jeff and Judd are fairly Bearish into year's end --they are looking for Dow 8500 -- but they like to occassionally switch things up, and change perspectives. Its a good mental exercise, and can often be revealing.

Those in the Bearish camp -- I call them (us) realists -- need to do a few things prior to putting on their Bull tinted glasses

"Suspend your belief that we are in a bear market. Ignore the fact that we are in the worst six-months of the most dangerous section of the presidential election cycle. Discount the inverted yield curve, the fact that we haven’t had a serious recession in decades and the fed resembles a rudderless ship adrift. Accept that the housing market is going to have a “soft landing”. Forget about the missiles flying in Iraq, Israel, Afghanistan and North Korea."

OK, got that?  Now you are good and bullish -- and here is why the real Bulls think you ought to stay that way:

1) Corporate earnings have been good and no major company has had significant earnings warnings so far. As long as the corporate balance sheets remain strong the markets will push forward.

2) Iraq is not as bad as the media makes it out to be. Oil production is up and the US has accomplished a lot of good things that don’t get reported. The Bush doctrine may still prove successful and if it does, stability in the Middle East will follow.

3) The economy is strong and inflation is in check. Moreover, the Greenspan/Bernanke measured rate increases may slow the economy perfectly just as it did in 1994-5.

4) This economy has weathered unbelievable shocks and has come out of it relatively unfazed. The market has grown callus to hurricanes, war, terrorism, energy prices and scandal to name but a few. Geopolitics and crisis no longer impact the market as it has in the past.

5) The US consumer is inexhaustible. If $70+ barrel oil hasn’t changed spending habits nothing will. Americans are rich and will stay that way.

That is the Bull case. If you agree with these 5 items, you should be long; Hell, you should be leveraged long. For those of you who disagree, you should be neutral at best, short or leveraged short when the time is right.

When should you become Bullish (for real)?  Most likely, according to Jeff & Judd, when we pull our stakes and set up in the Bull camp, (and most likely will be in the minority again).


Stock Trader's Almanac
June 20, 3006

Tuesday, July 11, 2006 | Permalink | Comments (9) | TrackBack (0)

NFP: much ado about very little

The dismal set has gotten all hot and bothered over the preliminary ADP data, thought by some to be an early read on the NFP report. According to  National Employment Report from Automatic Data Processing, the "private sector added a seasonally adjusted 368,000 nonfarm jobs in June."

It turns out that the ADP data is compiled, seasonally adjusted, and massaged in a very different manner than BLS does.

Regardless, its actually much ado about very little. Although NFP is eagerly awaited each month by wonks of all stripes (present company included) today's number is unlikely to represent a significant departure from the well established trend that has developed since the 2001 recession ended.

One point does not a trend make. And even if today is a killer number, we have seen what's been in place for nearly 5 years -- and it has been none too encouraging.

Why? The simple fact is that this recession recovery cycle has been historically very weak in terms of private sector job creation. Indeed, depending upon how you measure it, this is the first or second worst cycle since WWII.

The present cycle is overly dependent on government jobs. Its seen a hugely disproportionate number of private sector employment overly Real Estate reliant. These positions are more the product of government stimulus -- i.e., ultra low rates -- than they have been of an organic nature. Further, many of the remaining non real estate jobs have been disproportionately of the lower paying / weaker benefit variety than the jobs they are replacing.

And as the recent spate of layoffs in construction, mortgages, and real estate brokerage reveals, as rates rise the new jobs turn out to be somewhat more temporary in nature than originally believed.

So regardless of the outcome of today's report, it is but one number in an ongoing series. And the prior series has been rather disappointing from a macro perspective.

Prior to the ADP report's release, the consensus was for 170,000 nonfarm jobs; that's now been bumped up to 200k.

I'm sticking with the under.

Friday, July 07, 2006 | Permalink | Comments (23) | TrackBack (1)

Ignore Inverted/Flat Yield Curve at Your Own Risk

We have discussed the impact of an inverted yield curve repeatedly in the past. Much of the mainstream has denigrated the historical record of using this relative unusual relationship between yields as an indicator. They have strained credulity to somehow reach the conclusion that it really is different this time.

From Birinyi Associates, here is the recent track record of what they call "Intentional curve inversions:"


Source: Ticker Sense


This seems pretty conclusive that there is a correlationn between the shape of the curve and subsequent recessions.

And these tidbits from Jim Stack of Investech Research agrees. He points out:

• The flat yield curve shows an 88% probability of a recession beginning sometime between now and the end of next year.

• The yield on the 10-year Treasury Bond hit new 4-year highs this week.

• Even excluding energy, the CRB Spot Raw Materials Price Index is showing the highest 4-year inflation
rate in 25 years.

• Of the past 10 tightening cycles by the Fed, only 2 resulted in a soft landing (without recession).


Intentional Inversions    
June 30, 2006

Neutralizing risk
Jim Stack
Vol06 Iss08
Technical and Monetary Investment Analysis
Investech Research, June 30, 2006

Saturday, July 01, 2006 | Permalink | Comments (28) | TrackBack (0)

1/4 point, or . . . ?

I simply don't know how all this 50 basis point chatter got started and pinged around Wal Street like its a likely option.

Hell, why only 50 ? Why not 100, if the economy is so damn strong?

Let's open up a thread on this: 

Does anyone think that much besides a 1/4 point is in the cards tomorrow? Major language change? And what might Mr. Market have to say about all this.


Wednesday, June 28, 2006 | Permalink | Comments (67) | TrackBack (0)

CPI Null Set (via The Economist)

This is a classic example of working the refs: If enough long-only fund managers/sell side pundits spew the same misleading nonsense long enough, it will eventually find resonance somewhere in the mainstream media.

Today's case in point is from The Economist, a publication that ought to know better. They not only focus on the Core CPI, but they take it a step further: Core CPI ex Housing OER.

First off, I need someone to explain why food and energy is considered volatile -- if the volatility has been exclusively in one direction. That's not merely volatility, that's a trend

Second, let's credit The Economist with creating a whole new category of measuring increasing prices: Inflation ex inflation (ex inflation). That's right, we take the basic measure of inflation, remove the vital components of life consumed by every living human being (food and energy). Then, just in case that is still too inflationary, remove Housing (see chart below). 

That's Inflation ex inflation (ex inflation). 

We should take it a step even further. I propose a whole new category to measure inflation: CPI Null Set. Start with the basic CPI, then go to the Core, removing food  and energy. Then take out housing. Then remove everything else. Ta-da! No inflation!

Here's an excerpt:

Cfn876 "But much of that jump is thanks to a sharp rise in the cost of housing (which makes up almost 40% of core CPI), particularly the category of “owners' equivalent rent” which estimates the cost of living in a house by looking at rents charged on similar properties. Although this measure makes sense in theory (by living in your house you forgo rental income), it may now be overstating inflationary pressure.

As the housing market has slowed, fewer people are buying property, choosing to rent instead. That has pushed up rents. In turn, owners' equivalent rent has risen too, even though homeowners have seen no change in the actual costs of owning their house. Because owners' equivalent rent is estimated net of utility prices, recent falls in gas and electricity bills have paradoxically made matters worse.

Statistical quirks, in short, are distorting the picture. But what should central bankers do about it? Some suggest that owners' equivalent rent should simply be dropped from the inflation index. That is what European statisticians have done. But credible central bankers cannot suddenly ignore an inflation component when it starts behaving in ways they do not like. That was the mistake made in the 1970s, when officials deluded themselves that inflation was under control by excluding ever more prices from their indices."

Funny, I do not recall The Ecomomist discussing how OER understated inflation over the past 5 years. Where were you guys? Oh, that's right, no one was working the refs then. I guess quirks in reporting standards only matter if it impacts someone's portfolios/bonuses.   

As poorly considered as that was, the Brits do manage to redeem themselves with a paragraph towards the end of column:

"The bigger point is that even if you take out housing costs the recent acceleration in core consumer prices does not disappear (see chart). And a variety of other gauges suggest that underlying inflation is on the high side and rising. The deflator for core personal-consumption expenditure (PCE), Fed officials' favoured index, was up 2.1% in the year to April. The “trimmed-mean PCE deflator”, calculated by the Dallas Fed, which excludes those prices that have risen and fallen the most before taking a weighted average of the rest, is up 2.4%. The “median consumer-price index”, calculated by the Cleveland Fed, is up 3%. Look at these figures and the surprise is less that the central bankers are now so jumpy about inflation than that they sounded so sanguine earlier this year." (emphasis added)

Glad to see someone across the pond hasn't drank the kool-aid.

Hey guys: You were on the verge of being punk'd. Get with it.


American inflation: Feeling the heat
Jun 22nd 2006 | WASHINGTON, DC
From The Economist print edition

Monday, June 26, 2006 | Permalink | Comments (27) | TrackBack (0)

Call to ARMs

Alan Abelson hits on a favorite theme of ours: Bad financial advice given by a certain former Federal Reerve Chairman:

"ANYONE KNOW A GOOD LAWYER? Before you accuse us of cavalierly perpetrating an odious oxymoron, rest assured we're using "good" in the sense of professional superiority, certainly not moral rectitude. And what inspires our request is we're trying to prepare for a flood of requests from angry readers hot to sue Alan Greenspan.

Be assured as well that we would earnestly seek to discourage such action. For one thing, Mr. Greenspan is a well-meaning and gentle soul, known far and wide for his generosity (they don't call him Accommodating Al for nothing). For another, as the New York Times reported last week, chasing ambulances is already a lavishly rewarding occupation. More so, for sure, than tending to the unfortunates being hauled to hospitals in those ambulances, as evidenced by a study that found lawyers' incomes between 1995 and 2003 rose 7%, while your average sawbones over that same stretch suffered a 7% decline in his take-home pay.

But the incontrovertible if sad truth is that Mr. Greenspan did offer financial advice using, what's more, the bully platform of a congressional hearing to make his pitch.

And the even sadder truth is that any innocent who chose to follow his advice is now the poorer for having done so. That Mr. Greenspan has recently received a huge advance for a book on his life and happy times as a famous economist and revered civil servant is, alas, a cinch to only whet already ravenous litigious appetites.

More specifically, Mr. G stands guilty of committing a capital crime several years back by regaling the peasants, who considered his every word a divine utterance, on the joys of adjustable-rate mortgages (as opposed to the old stodgy fixed-rate variety).

As it happened, he couldn't have picked a worse moment to make what Stephanie Pomboy of MacroMavens nicely dubs his "call to ARMs." Yields were their lowest in 40 years, but poised to begin a remorseless climb up the slippery slope.

The masses who rushed to follow the master's advice are only now starting to feel the pain of their folly. Stephanie reckons that some $1 trillion of adjustable-rate mortgages are due to be reset this year and another $1.7 trillion next. In the event, legions of homeowners will have to cough up 25% more every month and, for some, the bite will be as much as 60% greater...

Note that we made the same observation (in 2004) about this horrific advice.  Back to Abelson:

Much as we sympathize with their plight, the hapless borrowers have only themselves to blame for failing to perform sufficient due diligence before acting on Mr. G's urgings. Had they made even a cursory effort to take his measure, they would have known better. For though not always wrong on his projections or wildly off on his timing (he isn't, after all, a financial journalist), he invariably has been wrong on the big ones. The only thing worse than his misdiagnoses have been his proposed remedies, which consisted mostly of the same old snake oil of easy money and easier credit. He was always ready with a fix, never with a cure.

Most notably, he lost his nerve when confronted by a runaway stock market and what to do about it. His politically correct but economically inane answer was essentially...nothing. When equities inevitably came back to earth with a horrible thud, he sought to distract us simple folk from the smoking ruins by creating the greatest housing bubble since shelter-seeking man first crawled out of his dank cave.

Now, that bubble's losing air rapidly and bad stuff is beginning to happen. Mr. Greenspan has fortuitously or craftily -- or both -- slipped out of the line of fire and, presumably, is busily scribbling away, offering, as the key player, his priceless perspective on the great bull markets in stocks and houses. (The perspective may be priceless but, the book will probably, depending on length, go for close to 30 bucks a copy, with the usual discount at Barnes & Noble.) We can hardly wait to read his account. But, then, we're a real sucker for anything with a financial theme, especially fiction."

We couldn't agree more -- we have hit upon quite similar themes several times. First, in Ignore the Cheerleader-in-Chief (If no RM, see this) and more recently, in Myths of the Greenspan Era.

Consider the following fed chief foibles which w ehave pointed out in the past:

• October 8, 2004 "The impact of the current surge in oil prices, though noticeable, is likely to prove less consequential to economic growth and inflation than in the 1970s." 
-Speech to National Italian American Foundation in Wash, D.C., Federal Reserve Chairman Alan Greenspan said he's not worried by the rise of crude oil prices to a record $55 a barrel.

• July 20, 2004: Rising energy prices "should prove short-lived"; crude prices have risen nearly doubled since then.
-Testimony before Congress

• May 2003, Greenspan warned of potential Natural gas shortages; prices tumbled shortly thereafter on increased supplies.

• Summer 2004: His advice to would-be home owners, praising the virtues of adjustable-rate mortgages when fixed-rate loans were near half-century lows.

These are but a few of his calls; If you see a pattern, give yourself a gold star . . . or better yet, just buy some gold, as his easy money policies are the reasont he metal has doubled over the past 5 years.



Call to ARMs
Alan Abelson
Barron's MONDAY, JUNE 26, 2006

Saturday, June 24, 2006 | Permalink | Comments (40) | TrackBack (0)

The Return of Abelson

Bol_logo_top_page_05"AS WE WERE SAYING BEFORE WE WERE SO rudely interrupted by a man dressed in a white smock and wielding a scalpel (thank heavens he left his box-cutter at home), the stock market looks a bit worse for the wear."


So says Barron's Alan Abelson, usually one of Wall Street's most visible Bears. Just his luck -- or was it the Trading Gods having some fun? -- that he managed to be out of service for the most bearish period in 3 years. Traders, being a superstitious lot, will soon be begging Abelson to "let us know the next time you go in for a procedure" -- so they can get short.

Regardless, whatever the  man dressed in a white smock removed, it wasn't his arch sense of humor or acid tinged tongue:

"The impact of the massive disturbance was global in every sense: Not only were its terrible tremors felt far beyond the narrow canyon of capitalism in lower Manhattan, but they commanded notice in quarters much loftier than trading floors or commodity pits. We've not the slightest doubt, for example, that what prompted the famed cosmologist Stephen Hawking early last week to urge earthlings to create settlements in space was, pure and simple, fear of the effect of crashing markets on the human race."

But the key to Abelson's return is his clear eyed take on inflation, which comports squarely with our own views:

"FOR OPENERS, OUR HUNCH IS THAT MR. BERNANKE'S concerns about inflation, despite his mucking up the message with all that rubbish about inflationary expectations, have more than a modicum of merit. And our conviction on this score is only strengthened, of course, by the fact that so many pundits pooh-pooh inflation as a problem. Indeed, if anything, we fault the chairman for his evident sympathy with the argument that the fearsome upward spiral in the price of crude, so far, anyway, hasn't been exerting all that much impact in the economy at large.

Apparently, Mr. Bernanke, like his critics, needs to get out more. Oil is a very sneaky commodity. Our old friend and revered Barron's contributor, Abe Briloff, likes to describe certain stealth accounting practices as comparable to a bikini: what they reveal is interesting, what they conceal is vital. Oil is something like that: Its uses are readily manifest, but it plays a far bigger and more critical role in our lives than is easily perceived.

Food is a good example. Farmers are unusually dependent on oil and its by-products, which go into everything from fertilizer to the gas tanks of their huge guzzling combines. OPEC's shenanigans thus have a pronounced effect on the price of victuals, the only evidence of which confronts the consumer at the supermarket checkout counter. And the fact is, whatever the official tally shows, anyone who isn't clinically anorexic can attest that eats continue to cost a heck of a lot more these days, whether you're dining in or out.

The rich price of petroleum is affecting agricultural commodities in a less visible but increasingly ponderable fashion as well. The highly, perhaps overly, publicized virtues of ethanol, to illustrate, has prompted a bit of a run on corn and prices of the stuff have responded accordingly. This kind of thing can be contagious. So it's at least conceivable that grains, which generally have not enjoyed the kind of whirl given to metals, say, will prove to be late speculative bloomers in this big commodities bull market. Not exactly a cheerful prospect for those like Mr. Bernanke who are paid to fret about mounting prices . . .

The principal engine of the global inflationary surge is, it's no secret, China. And the latest data from that monstrously growing economic dragon shows it's still breathing fire at a fantastic rate. Last month, the country's industrial production rose an astonishing 17.9% and in the first quarter of this year, GDP sprinted ahead a blazing 10.3%. Besides an unshakeable thirst for oil, China has been bolting down industrial commodities at a truly awesome pace. According to Morgan Stanley's Steve Roach, in '05, it accounted for 50% of the growth in aluminum consumption, 84% of the rise in demand for iron ore, 108% of the increase in consumption of steel, and 115%, 120% and 307% in the growth of worldwide demand for cement, zinc and copper, respectively. How do you say "wow!" in Chinese?

And despite Beijing's solemn vow to cool it, the 19% jump in the money supply in May suggests otherwise. We remain skeptical that the folks in charge of China's so-called command economy have all that much interest in cooling it and all that might portend for a huge restive and grossly underemployed population. The only thing that will truly cool the red-hot Sino economy, we fear, is implosion. That'll happen, but not tomorrow or the day after. Which means the odds strongly favor a fresh lease on life for the boom in commodities...and their prices.

So ask not why Ben's antsy about inflation. He should be."


Welcome back.


When Ben Burped
Barron's Monday, June 19, 2006

Saturday, June 17, 2006 | Permalink | Comments (9) | TrackBack (0)

Much Ado About Nothing

Ecochartscpi_ Everybody seems to be all abuzz about today's CPI number. Its no big whoop.

Why? At this point, I think we can all agree that a 1/4 point increase at the June FOMC meeting is a foregone conclusion. So that makes today's data more or less irrelevant to that meeting. Even if the inflation data comes in extremely benign, its but one point in a data series. Its doubtful it will impact the Fed's thinking about the next tightening in any meaningful way.

And the August FOMC meeting is so far away, and there will be so much additonal data between now and then, including 2 NFP reports, that today's CPI will have long been forgotten.

By August, the Fed will most likely be forced to acknowledge that either a) the economy has slowed enough that the tightening cycle is over;  or 2) Inflation has gotten away from us and we need to keep tightening. By August, even Greenspan would have to admit that Goldilocks is dead . . .

Either way, today's data point, at least as far as the Fed is concerned, won't change very much.

On the other hand, a benign number -- or even one that hits consensus -- could light up the markets. The sentiment readings have all hit extremes, with the Put Call ratio, the Bull/Bear  ratio, and the percentage of stocks above their 200 day moving average at levels typically associated with intermediate bottoms.

UPDATE June 14, 2006

Mike Darda adds:

The headline CPI rose 0.4% m/m in May while the core CPI rose 0.3% for the third consecutive month. The headline CPI is up 4.2% on a year-to-year basis while the core CPI is up 2.4% y/y. Three-month growth in the core CPI (annualized, not compounded) has risen to 3.7%, the fastest pace in a decade. Owners’ equivalent rents, which make up nearly one-third of the core CPI, advanced 0.6% m/m during May and 5.5% A.R. during the last three months, the fastest since 1990. On a year-to-year basis, rents are up 3.3%.

Nothing to see here folks, move along.


As Art Laffer said last night, there's no inflation here . . .

Wednesday, June 14, 2006 | Permalink | Comments (38) | TrackBack (0)

How the Fed Chief Gains Credibility

One of the best things about doing TV is who you bump into back stage or the green room. On Thursday's K&C show, I ran into CNBC's Chief Economist, Steve Liesman in makeup (I've chatted up Steve before from doing Squawkbox).

We started discussing markets and the Fed. Steve explained the current situation using a biblical parable -- the tale of Abraham and Isaac. I told him this was a wondeful parable, and offered him the Big Picture as a platform to publish it.

He agreed, and so without further adieu, here is Steve Liesman's explanation of how a new Fed Chair gains anti-inflation credibility -- by his willingness to sacrifice his only son, the economy:


How the Fed Chief Gains Credibility
a biblical tale of credibility and faith

by Steve Liesman

"We throw this idea around a lot, but we talk little about it. The usual idea is that he shows this by raising interest rates to fight inflation. But I think the idea goes deeper. What markets want to know, what makes them sleep at night and not fret about inflation, what the real reason behind the Greenspan and Volker Puts is this: at the end of the day, the Fed Chairman is willing to sacrifice economic growth to fight inflation, to take on the body politic and risk his popularity in that fight and to cause a recession if needed.

This may sound absurd (but might not be in the context of Bernanke), but think of the Biblical story of Abraham and Isaac. Only by showing that he was willing to sacrifice his son could Abraham prove the credibility of his faith. This is the test that markets are putting Bernanke through.

Note, he doesn't have to cause a recession, just make markets believe 100% that he will to fight inflation. And I mean 100%. There is no wiggle room.

David Rosenberg of Merrill Lynch said this: If we see a rate hike after the raft of soft data posted in recent weeks, then we can only draw the conclusion that in the name of rebuilding anti-inflation credibility, the central bank is willing to sacrifice the economy.

In fact, I believe that is the only way to rebuild anti-inflation credibility. I would add that Bernanke would have faced this test whether or not he talked to Maria. Greenspan, remember, is blamed for ruining Bush I's reelection chances. Volker caused a recession.  Of course, we're talking about inflaton being at a very low level now. But that's balanced by the fact that the additional amount Bernanke has to tighten to gain credibility is much lower than the hurdle that Volker faced.

Note that we can now make an economic assessment. Is 25 or 50 basis points of additional tightening, and the increased economic drag it will cause, worth the value we'll get from a chairman who has the market's confidence? I'd say that every additional year that he remains in office, the less the cost of that additional tightening."

-Steve Liesman
Senior Economics Reporter, CNBC



Thanks Steve -- enjoy your vacation . . .

Tuesday, June 13, 2006 | Permalink | Comments (21) | TrackBack (0)

What Happens if Inflation Is Overstated?

The NYT's Floyd Norris jumps the gun on CPI and Owner's Equivalent Rent this morning:

Norris_oer_1"Since 1983, the government has measured the price of homes not by looking at house prices but by computing what it calls "owner's imputed rent." That is the rental value of the house you own. It accounts for nearly a quarter of the entire Consumer Price Index.

When the change was made, the government provided statistics indicating that previous inflation rates would not have been very different under the new method, and that remained true until 1996.

Since then the home price index maintained by the Office of Federal Housing Enterprise Oversight has doubled, while the imputed rent figure has risen by less than a third.

Had the government computed the Consumer Price Index using actual home prices since 1996, I estimate that it would have risen by an average of 4.1 percent a year, as opposed to the 2.5 percent reported. The core rate — inflation excluding food and energy costs — would be 4.2 percent, not 2.2 percent.

Perhaps the Federal Reserve was too hesitant to raise rates, and thus allowed speculative bubbles to form, because it was seeing inflation through rose-tinted glasses.

But now the problem could be the opposite. If the housing boom is ending, rental costs may start to catch up with house prices. The reported inflation rate would be higher than the real rate, at least to people who say the best way to measure home prices is by measuring home prices."  (emphasis added)

Here's the problem with this approach: After years of CPI definitively understating Inflation, we are now at a junction where its a slim possibility that -- off in the future -- when CPI may (repeat MAY) possibly overstate inflation. 

For that to happen, rents would have to tick up significantly. With OER about a third of the core CPI, medium size increases in rent beyond the historic trend would have an impact on BLS reported inflation data. 

Think about this for a moment: In order for that to happen, we would needs a fairly hefty shift in demand for rental properties nationwide - beyond the available supply. We have yet to see any evidence of this shift; Given the massive buildup in inventory recently, there is still much more than enough supply to meet demand.

Indeed, considering all the spec properties built/bought -- think of the gazillion new condos in Florida, the surge in Las Vegas, Arizona, San Diego -- lots of rookie Real Estate speculators may soon find themselves as unwilling landlords. This will especially be true for those who are unable to sell their properties beause they cannot sell for less than their (interest only) mortgages. If they cannot absorb the big hit, their only option is RENT IT.   

To summarize:

1) Inflation has been significantly understated by the BLS for the past 10 years due to OER;

2) With the Real Estate boom cooling, the possibility exists for an upswing in rentals sometime in the future;

3) If that occurs in significant enough numbers, that might in the future, overstate inflation;

4) However, before that happens, all the excess inventory built recently would need to be absorbed into the Real Estate market.

5) All this presumes the economy doesn't slow all that much if at all;

Coming Soon: New Rental Property Supply:


Source: Northern Trust, New Home Inventory 1965-2005



Don't look for OER to overstate inflation anytime soon . . .


UPDATE JUNE 10, 2006 6:27am

The WSJ reports "It's no longer a renter's market" as rental prices rise 3%:

"For years, rents have been flat or falling in cities nationwide -- a result of the booming home-sales market, which transformed scores of renters into owners. But as the housing market cools, rentals are once again in demand, liberating landlords in many markets to raise rents at the fastest pace in years. They're also cutting back on the goodies that previously helped lure tenants, such as a free month's rent or a free DVD player.

While renters have had an easy ride for years, the current bout of rent increases could prove to be a jolt for many Americans, from seniors looking to downsize to recent grads looking for their own place. Average effective rents -- or what tenants pay after taking concessions into account -- are expected to rise 3% this year, according to Reis Inc., a real-estate research firm. Rents began picking up last year after several years of softness. As recently as 2002, rents fell 1%."


What Happens if Inflation Is Overstated?
NYT, June 9, 2006

Rising Rents Jolt Tenants
Cooling Housing Market Adds To Demand in Many Cities;
WSJ June 10, 2006; Page B1

Friday, June 09, 2006 | Permalink | Comments (38) | TrackBack (0)

A Consensus is Developing: Blame Greenspan

I love when an idea simultaneously blooms all over at once.

If we saw the same meme suddenly pop up all over the mainstream, that would be one thing. My assumption would be that it was today's takling points, and I would be a lot more sleptical.

But when 4 pretty independent thinkers all reach similar conclusion, I pay close attention.

First up, Jeff Matthews wrote this on Tuesday:

“Every time he opens his mouth, the market tanks.”

That’s what I kept hearing during yesterday’s market sell-off.

“He” is, of course, Ben Bernanke, the poor guy who had to follow in Alan Greenspan’s hallowed footsteps as Chairman of the Federal Reserve.

Under Bernanke, the Fed has raised interest rates precisely twice. Under Greenspan, the Fed raised rates fourteen times. But, under the twisted laws of Human Nature, Bernanke is Guilty as Charged. His crime: spoiling the party.

Now, Greenspan raised rates fourteen times because he had previously dropped them to virtually zero, triggering the greatest home-building speculation boom in the history of the country. Al figured—and with his reputation in Washington, who was going to argue?—the Fed could gently deflate the Greenspan Housing Bubble in a way that everybody would win.

But Bubble aftermaths are never pretty.

Just look at the last one. It occurred only five years ago, when Greenspan himself tried likewise to gently deflate the greatest new-era business speculation boom in the history of the country—the Greenspan Internet Bubble—and triggered a recession.

So, who’s the villain here? A guy who tells the world inflation is running a little high and maybe rates aren’t necessarily going down any time soon?

Or his predecessor, whose twenty years in control led directly to $70+ oil, $300+ copper and $600+ gold?

Next up is Doug Kass' musings (Wednesday)

Don't Blame Bernanke:  Investors' inertia (and highly leveraged invested positions in overvalued market, which served to reduce risk premiums to preposterously low levels) is one of the situations that should be blamed for the recent market slide and increased volatility. At the slightest hint that the Fed might have to go further, their portfolios were decimated in short order. Stated simply, they got greedy and lacked foresight. Don't blame Bernanke.

Greenspan Is the Real Culprit 
But the real culprit -- never discussed on CNBC, Bloomberg or elsewhere -- is former Fed Chairman Alan Greenspan who not only raised interest rates on 14 separate occasions (before Bernanke's paltry two increases) but who previously took interest rates to artificial and generational lows (the fed funds rate bottomed at 1%). That strategy's economic impact was to usher in another bubble (in real estate), which served to stoke consumer spending through the extraction of capital out of the housing stock. In turn, commodities followed housing ever higher. By the time the new Chairman took over in early 2006, today's problems were already percolating. Blaming Bernanke for Greenspan's mess would be like blaming Ed Breen, who followed convicted crook Dennis "Denny the K" Kozlowski as CEO of Tyco (TYC). Don't blame Bernanke.

Post Late 90s Policy Decisions Created Today's Market Position The unusual nature of policy decisions post the late 1990s bubble served to put the markets in the position they are today -- a position inherited by policy makers. As a result of the aforementioned monetary loosening, for the first time in modern economic history, consumer debt (installment and mortgage) increased in the recession of 2001-02. A series of 14 incremental and gradual tightenings, intended to wean our economy off of easy money, sowed the seeds of the inflation we see today. Don't blame Bernanke.

Acknowledge Other Causes for Market's Decline So, blame the market's decline on avaricious and poorly positioned hedge funds, on former Chairman Alan Greenspan bubble-inducing monetary policy, or on the natural cyclical nature of markets, or "Blame it on the Bossa Nova." But don't fixate and blame Ben Bernanke.

Then last night, Slate's Dan Gross was even more specific, saying, The Ghost of Greenspan is haunting the Fed:

But Bernanke's rhetorical vacillation isn't the Fed's sole contribution to the recent volatility. It's his new methods. Last week, Bernanke told a Senate committee that economic data released in the coming weeks would help determine whether the Fed would raise rates at its next meeting at the end of June. "Our thinking on this will be very data-dependent." Now, the Fed has always been "data dependent." But the implication of Bernanke's comments was that the Fed would essentially make decisions on the fly, based on the latest headlines. So, every time a new piece of information comes in, like last week's lame jobs figure, investors have to guess at how that might impact the Fed's decision. The fact that economic data are frequently contradictory contributes to investors' confusion.

In theory, this type of transparency and disclosure was precisely what the market wanted from the new Federal Reserve chairman. For years, investors have complained that Greenspan's Fed was too opaque, too hard to read. But now it turns out that trying to interpret public data is even trickier than interpreting the oracular Greenspan.

The Bernanke-era volatility can also be blamed on the stature gap. Under Greenspan, the Fed generally spoke with a single voice, Greenspan's, and didn't engage in any public debate. Sure, the other Fed governors and heads of the Fed's regional banks were well-respected economists. And, yes, their testimony and comments were dutifully reported by the financial wire services and picked over for clues as to what the Fed might do next. But they were like so many planets to Greenspan's sun. Today, as would have been the case regardless of Greenspan's replacement, Bernanke lacks Greenspan's weight. And as a result, the comments of people who were perceived as peripheral players in the past now have a greater capacity to move the markets.

Lastly, Marketwatch's David Callaway puts this all into context:

"But what the market is missing among all this tough talk is that transparency from our financial leaders is a good thing. Sure he spooked the markets about inflation. But should they really have been that spooked?

In its traditionally coded way, the Fed has been banging the drum for more than a year about inflation. But with no visible signs of it -- other than soaring energy prices -- investors didn't believe the central bank. Now they do. It took plain talk to accomplish that.

What the market is also missing is that just as plain talk can scare investors, it can also excite them. The day will come when Bernanke will blurt out something positive for investors, like "I think that should do it." Then it's off to the races.
The problem with the financial markets is a lack of transparency. That's why an entire industry has grown around central bank watching. Trying to decipher what these bankers are saying is a global financial pastime. Economists and financial journalists spend their lives studying snippets of sentences for underlying intent. Now we have Bernanke to spell it out for us and we're upset?

For the markets, this is tough medicine. But they had a great run in the first quarter and in April, and we're overdue for some sort of setback.

UPDATE: JUNE 12, 2006 6:57AM

Bloomberg joins in:  Bernanke Can Thank Greenspan for His Troubles   

"If you consider that a "neutral'' federal funds rate is probably around 4.5 percent, and that the rate was below that all of last year, one must conclude that the Fed had its foot on the gas right up to Greenspan's departure. We are in this difficult spot because the Fed was far too easy when growth was hot last year, leaving all of the tough work for Bernanke.

Whenever there is a tightening cycle, markets are always puzzled and dismayed by the question, "When will the tightening end?'' If Greenspan were at the Fed right now, market volatility would be the same, because the Fed's uncertainty about when to stop would be the same.

He isn't at the Fed now, and somebody else is, a person who is supremely able to deal with the difficult task of managing monetary policy. But Bernanke's job would be a lot easier now if the Fed had simply increased the federal funds rate enough last year so they could have halted the increases in Greenspan's last meeting in January"

Shooting the Messenger
Jeff Matthews is Not Making This Up,
Tuesday, June 06, 2006

The Blame Game
Doug Kass
The Edge, Street Insight 6/7/2006 7:31 AM EDT   

The Ghost of Greenspan
It's haunting the Fed.
Daniel Gross
Slate, Wednesday, June 7, 2006, at 6:39 PM ET

Loose lips Bernanke just what market needs
Commentary: Tough talk brings transparency
David Callaway
MarketWatch, 12:01 AM ET Jun 8, 2006

Thursday, June 08, 2006 | Permalink | Comments (26) | TrackBack (0)

Tracking Bernanke

Kudos to Liz Rappaport, the Markets Columnist at, for putting together a terrific column on the flip flops of Fed Chair Ben Bernanke.

Here's a chart of gentle Ben's public statements that she put together:

Bouncing Bernanke:
A brief history of the new Fed chairman's communication efforts
Event Key Comment(s) Perceived as Hawk or Dove
Nov. 16: Confirmation Hearing, Senate Banking Committee "In 2003, there was an episode where there was clearly miscommunication between the Federal Reserve and the bond markets [regarding deflation risks] , and it caused a significant fluctuation in the bond markets. Clearly there was a misunderstanding about that risk." Hawk, or at least attempt to dispel dovish perception.
Feb. 15-16: Semiannual report to Congress
  • "A leveling out or a modest softening of housing activity seems more likely than a sharp contraction."
  • Not worried about the inverted yield curve -- low long-term rates will keep the economy moving.
  • The policy response to inflation need not be as great as in the '70s, even with the move in energy prices.
  • Not worried about the current account deficit, but would be concerned if it changed too rapidly.
  • Mixed
    March 20: Speech, Economic Club of New York
  • "I would not interpret the currently very flat yield curve as indicating a significant economic slowdown to come, for several reasons."
  • "To the extent that the recent behavior of long-term rates reflects a declining term premium, the policy rate associated with a given degree of financial stimulus will be higher than usual. But to the extent that long-term rates have been influenced by macroeconomic conditions, including such factors as trends in global saving and investment, the required policy rate will be lower."
  • Mixed, but interpreted as somewhat hawkish.
    March 28: FOMC Statement "Possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures." Hawkish
    April 18: Minutes of March FOMC meeting. "Most members thought that the end of the tightening process was likely to be near, and some expressed concerns about the dangers of tightening too much, given the lags in the effects of policy." Dovish
    April 27: Testimony, Joint Economic Committee
  • "At some point in the future the Committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook."
  • "Significant uncertainty attends the outlook for housing, and the risk exists that a slowdown more pronounced than we currently expect could prove a drag on growth this year and next."
  • Dovish
    April 29: White House Correspondence Dinner Tells CNBC reporter markets were "wrong" to react to his congressional testimony as necessarily telegraphing a pause. Bernanke says it's "worrisome" people don't see him as an "aggressive inflation fighter." (Chicken) Hawk
    May 10: FOMC meeting "The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information." Not as dovish as traders hoped.
    May 23: Q&A, Senate Banking Committee CNBC episode was "a lapse in judgment on my part." Maria Culpa
    May 31: Minutes May FOMC Meeting "...a number of factors augmenting the upside risks to inflation." Plus, FOMC considers 50 basis points. Hawkish
    June 5:
  • "core inflation...has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth."
  • "Some survey-based measures of longer-term inflation expectations have edged up, on net, in recent months, as has the compensation for inflation and inflation risk implied by yields on nominal and inflation-indexed government debt."
  • (Super) Hawk
    Source: FOMC Web site;



    The entire column can be seen here.

    Nice work, Liz!


    Market Suffers From Too Much Information
    Liz Rappaport, Markets Columnist
    The, 6/5/2006 5:43 PM EDT

    Wednesday, June 07, 2006 | Permalink | Comments (16) | TrackBack (1)

    Ben Steps Up

    A few quick points regarding the muscular comments from Bernanke:

    Friday's NFP Employment data added NOTHING WHATSOEVER to the Fed's understanding of the economy. Indeed, I would go so far as to suggest no single NFP adds much to anyone's understanding. It is but one point in a long data series, and any one data point -- too strong or too weak -- needs to be put into context. (You can see my context in Friday's debate with Cody).

    Second and perhaps more importantly, any group dealing with uncertainty must consider what happens if they are wrong. The options facing the Fed are overtightening and causing a recession, or under tightening and letting inflation getting away from them. IMO, the latter is the far worse option, and the new noise from the Fed is consistent with that (See here for more details).

    3rd, the bond vigilantes are returning, and that is reflected in the Fed Funds Futures. The hope of a pause should be dashed for quite sometime now (Not the pause itself -- just the hope of it).

    Last, Bernanke may have been too concerned with consensus building outside of the FOMC; I think the entire Maria episode made him rethink that, and reminded him he is no lionger in academia. In this vein, he seems to be no different from other newbie Fed Chairs, who took some time to get their sea legs.


    UPDATE: June 5, 2006  6:35pm

    Tony Crescenzi calls Bernanke's speech "Tough Love"


    Remarks by Chairman Ben S. Bernanke
    At the International Monetary Conference, Washington, D.C.
    June 5, 2006

    Monday, June 05, 2006 | Permalink | Comments (19) | TrackBack (0)

    NFP Day -- Abandoning the Over?

    In April, I deviated from the longstanding "Under" gamble and took the "Over." It was a winning bet.

    Last month revealed that April's release (for March jobs  data) was a mere exception to the rule. All the Katrina relocatees were finally caught up with by BLS. Like GDP, they reflected a surge which was really a push forward from Q4 2005. 

    The overall trend remains soft. While I have no particular feel for this month, the Bloomberg consensus for 170,000 (Reuters survey is for 175,000) shows that perhaps the Dismal Scientists have finally figured out that job creation is not what it is typically at this phase of a recovery. (Look for a big NYT story on this subject Sunday).

    I'm tempted to take neither the Over or the Under -- perhaps they (collectively) got it right this month. (And by right, I mean plus or minus 10k).   


    Update June 2, 2006 7:41am

    WSJ's Justin Lahart suggests we "Worry less about the total number than the wage component:"

    "But with the Federal Reserve on inflation watch, the number that matters most could be elsewhere in the report.

    The government's measure of average hourly earnings -- a proxy for wages -- has been marching higher. If the march continues, market players will worry the Fed has more wood to chop...

    Wages might have accelerated more than economists estimate. Private staffing firms surveyed by Bear Stearns analyst Andrew Steinerman said a tight labor market is allowing them to raise fees. If these businesses are able to charge higher prices for their services, maybe workers were able to charge more for theirs."

    Friday, June 02, 2006 | Permalink | Comments (13) | TrackBack (0)

    NYTime's Comment



    I finally lost my NYT cherry today, with a quote in an article about Ben Bernanke (and look who I'm quoted with):

    "Pundits began accusing Mr. Bernanke of vacillating.

    "In jest, I've been saying that Mr. Bernanke needs to regain his monetary manhood," Larry Kudlow, an economist and talk show host, recently told viewers on CNBC. "He was people-pleasing Wall Street. Now he has got to go back on message."

    Barry Ritholtz, an economic consultant and operator of an economic blog, the Big Picture, went further and called Mr. Bernanke the "Neville Chamberlain of inflation fighters."

    "I got the sense that Mr. Bernanke was appeasing the stock market," Mr. Ritholtz said in an interview. "It's not that he has to go out and prove his manhood and his street-fighting cred. It's just that he has to navigate at a particularly perilous moment in the economy, and he has to navigate absolutely flawlessly."

    pretty cool . . .


    2 New Captains of the Economy Face Volatile Global Markets
    NYTimes,  June 1, 2006

    Thursday, June 01, 2006 | Permalink | Comments (15) | TrackBack (0)

    Worst Case Scenarios: Why the Fed Tends to Overtighten

    Forget, for the moment, the specifics of the May 10 Fed Minutes. Instead, consider the decision making process the FOMC goes through.

    When making complex decisions with serious ramifications, it is useful to understand what is at risk if you are wrong. That one factor impacts various outcomes dramatically.

    Its a given that the future is unknowable. The complexity of the economy, random events, unexpected interactions, dumb luck -- force all forecasters to recognize the inherent possibility, and indeed, high likelihood of error. Typically, that recognition colors policy making. (Consider recent examples where expectancy analysis was ignored in the policy making process -- with dire results).

    Once you get through that process of error expectancy, then play out the various decision tree possibilities: The results are why the Fed tendency to overtighten is all but a fait accompli.

    And, we like it that way.

    Why? What is the worst case scenario if the Fed Overtightens? The economy slows, maybe we even have a recession. Not to make light of what is always a painful situation, but -- so what? Recessions are a normal part of the business cycle. The U.S. economy is flexible, multi-faceted and resilient enough that a mild recession -- or even a strong one -- is a minor inconvenience in the grand economic scheme of things.

    Consider: A recession reprices overvalued assets; It creates a cathartic cleansing that forces efficiencies where there were none before. It removes excesses that have developed.

    Has the U.S. ever not bounced back from a recession? Of course not. Over the next century, we will have a dozen or more recessions, and an equal number of recoveries. 

    But consider the alternative error:  What happens if Inflation is no longer contained -- if it gets away from them?

    That is a far, far worse outcome than a recession. I am old enough to remember the nightmare of the 1970s. I have no desire to live through THAT again (and I'm not referring to Disco, Bell bottoms or Nixon). It was FUGLY:

    1970s Inflation: Worse than Disco

    Source: Economagic

    Once inflation is no longer contained, it becomes a runaway wildfire. The Fed -- indeed, central bankers everywhere -- find it difficult to play catch-up. Inflation is self-reinforcing -- it forces everyone in the system to raise prices, pass along increases, demand higher wages. It feeds upon itself.

    The response? The Fed goes Volcker (now, a verb) on the economy: They force an even more severe recession. The medicine to recover from this is a brutal, economic chemotherapy. It can take a decade to recover from uncontained inflation -- or the cure. 

    That's the dilemma confronting the Fed. What is the worst case scenario if they are wrong and overtighten? We get some unpleasantness -- but nothing fatal. No one likes recessions, but they are a natural part of the business cycle. (We don't care for death either, but its a part of life). After the Recession, comes the Recovery.

    This is why the Fed tends to overtighten. We always -- ALWAYS -- rebound from a recession. Relatively quickly, also. But 1970s-style inflation is a spectre that haunts the dreams of all economists -- especially those who sit on the Fed.

    Given this choice of potential negative outcomes, what would you do?

    Thursday, June 01, 2006 | Permalink | Comments (39) | TrackBack (2)

    Recent Housing Data: Charts & Analysis

    It has long been our view that Real Estate is the prime driver of this economy, and its eventual cooling will be a major crimp in GDP, durable goods, and consumer spending. 

    4 Charts from Northern Trust are worth looking at to show how far along that process actually is:

    Median Home Sale Price
    Mortgages Apps
    New Home Inventory
    Single Family Home Sales

    Here's each chart with my annotations:

    Median Home Sale Price:  Putting aside for the moment the issue of "median" (it gets skewed when too many high end or entry level houses are the dominant movers) the chart shows rapid decelleration of price gains. I expect to see more of this over the next few quarters, as Sellers and Buyers engage in a stare down, as Sellers continue to gradually lose pricing power.   


    New Home Inventory:
    What can you say about this? Builders have created huge inventory. Its no surprise that the enormo increase in Supply has impacted prices (Demand). On this 45 year chart, the recent rise (since 2003) is historic!


    Single Family Home Sales:
    The long uptrend in Sales has broken; I do not know how far it retraces, but I imagine it will continue to do so as mortgage rates tick higher or the economy cools (or both). 


    Mortgages Apps: Another long uptrend broken; Same story as above:  Higher rates mean less sales and refinacing. The one mortgage bright spot I see is the refinancing of ARMs into fixed rate loans.    


    All charts courtesy of Northern Trust


    Housing Market Is Cooling Down, No Doubts About It
    Asha Bangalore
    Northern Trust, May 25, 2006

    New Home Sales - Headline Is Deceptive, Momentum Is Weak
    Asha Bangalore
    Northern Trust, May 24, 2006

    Wednesday, May 31, 2006 | Permalink | Comments (20) | TrackBack (2)

    Blame the Fed?

    As you might have suspected, I disagree with those who are blaiming today's whackage on the Fed; In particular, Michael Moskow's interview with CNBC's Steve Liesman. 

    Bob Marcin, whose views I always respect (tho don't necessarily agree with) blames Moskow as to the causes of the selloff.

    "In my opinion part of the market's decline is due to the Michael Moskow CNBC interview this morning. I think the Fed and Mr. Moskow just don't get it.

    They continue to press the rate hike story. It's a mistake. The real estate market is in disarray. Consumption is slowing. And much more slowdown is baked in the cake.

    And this glorious morn, we get to listen to Moskow pitch his "personal" inflation target of 1-2%. Well, that's absurd.

    Just 2 years ago, Easy Al took rates to zero because the PCE was at 1%. How can the deflationary depression scenario come out at 1% inflation, and an FOMC member have the same rate in his normal target range? You can't, period.

    If 1% gets us a Fed panic, I humbly suggest taking the range to 2-3%, with the midpoint being the real target. Then, the pause option becomes much more viable now.

    I am on the record calling 1% Feds fund a mistake. I want to be there for this call. I think a second half material slowdown is a done deal. Give me a 6% Fed funds this year and I promise you a recession next."

    Then why the sell off?

    There has been an ongoing technical decay in the markets for sometime now, and that's a reflection of all these seperate elements. The Fed is merely one (amongst many) issues weighing on equities. I would place a heavier emphasis on the emerging markets meltdown, the commodity correction, the dollar's slippage, WalMart's numbers showing high energy prices biting consumers, GM's downgrade, and the general real estate/housing slowdown, on top of all the cyclical factors we have mentioned.

    But since the Fed is the topic at hand, recall how we got much of this reflation/inflation: It was that very same 1% that lit the fire the Fed is now trying to contain.

    Consider the Hobson's choice dilemma all Fed Chiefs must face: On the one hand, if they overtighten, they will force the economy to slow too much, and risk a recession. On the other hand, if inflation gets away from them, it can become a runaway wildfire. They have a very hard time playing catch-up, given the self-reinforcing tendency of inflation to feed on itself. So they end up forcing an even more severe recession.

    I think the US economy is resiliant and multi-faceted -- and the Fed knows this. Historically, we have shown the ability to bounce back from all kinds of problems. The Fed knows this also.

    This pair of choices is why, IMO, the Fed tends to overtighten. The always rebounds from a recession, and relatively quickly, also. On the other hand, 1970s-style inflation haunts the dreams of all economists and especially those who sit on the Fed. I suspect soft landings are mere serendipity, and not the result of brilliant Fed policy.

    Given this choice, it's not too hard to see why the Fed is likely to over-tighten. Of they are wrong, we get a mild recession, which we always bounce back from. Let inflation get away from the Fed, and (shudder) it gets ugly.

    Hence, they do what must be done to keep inflation well contained . . .

    Tuesday, May 30, 2006 | Permalink | Comments (18) | TrackBack (0)

    Yield Curve Inversion

    Fed_yield Anyone else notice the brief Yield Curve Inversion this week? The 10-year yield slipped below Fed Funds rate for first time since the last recession.

    Chris Isidore of CNN Money has the details:

    "The inversion early Wednesday was different than the inversion that occurred late last year and early this year, when the 10-year Treasury yield fell below the yield on shorter-term Treasury securities.

    Wednesday's inversion came as the 10-year yield fell briefly below the fed funds rate, the Fed's short-term rate target, currently 5 percent. It was the first time that's happened since April 2001, the last time the country was in a recession.

    The 10-year yield dipped briefly below the fed funds rate Wednesday morning after a report showed a big drop in demand in April for cars, refrigerators and other big-ticket items known as durable goods.

    But when a report on new home sales came in above forecasts 90 minutes later, the 10-year Treasury yield edged back above the 5 percent level."

    I continue to believe an economic slowdown is in the offing as stimulus fades, and the pig moves through the python. Recession odds for 2007 keep increasing. This despite what Ben "CPI overstates Inflation" Bernanke has said:   

    "But in recent comments, Fed Chairman Ben Bernanke repeated the view expressed by his predecessor Alan Greenspan that an inverted yield curve is no longer a good indicator of a recession ahead.

    "In previous episodes when an inverted yield curve was followed by recession, the level of interest rates was quite high, consistent with considerable financial restraint," Bernanke said in a speech in March. "This time, both short- and long-term interest rates -- in nominal and real terms -- are relatively low by historical standards."

    Keep in mind that inversions are not binary -- i.e., inversion or not. The depth and duration of an inversion are significant and contain information. The inversion this past Wednesday was "short-lived and relatively narrow. Some of the pre-recession inversions in the past were far more pronounced." Compare this with prior inversions:

    "For example the gap between the 10-year yield and the fed funds rate were inverted for nearly 11 months and the gap reached 1.5 percentage points in January 2001, just before the Fed started cutting rates.

    The recession that started in late 2000 lasted until the fall of 2001.

    Still, an inverted yield curve is not something that can be ignored, the experts said.

    "I think it would be healthy to be concerned, given the track record of the curve being a warning sign," said Schlesinger. "It's important not to be trapped by past patterns. But it (the inverted yield curve) does raise a question about how far the Fed has to tighten."


    Yields throw the Fed a curve
    Chris Isidore, May 24, 2006: 3:35 PM EDT

    Sunday, May 28, 2006 | Permalink | Comments (7) | TrackBack (0)

    CPI Overstates Inflation? Puh-Leeze!

    Larry Kudlow has been flogging my Ben Bernanke as Neville Chamberlain quote for weeks now. So why do I think Ben Bernake is dovish on Inflation?

    His view of CPI data.

    Setting aside the rest of the dismal scientists idiotic obsession with the core rate of inflation, no one (outside of academia) is persuasively arguing that prices across a broad cross section of goods and services are not going higher, or the purchasing power of the dollar has slipped. One top of that, the supply demand equation continues to see the printing presses working overtime, further eroding dollar strength.

    I cannot find it at the moment, but prior to my “Neville Chamberlain” remark was some commentary by Fed Chair Ben Bernanke’s that the CPI overstated inflation.  That’s what led to my painting him an inflation dove.

    Today, we see once again a the same idea. In a letter to JEC Chair Jim Saxton, Fed Chair Bernanke reiterates the idea again. 

    "Most analysts believe that changes in the CPI overstate changes in the cost of living to some extent . . . The PCE price index likely is also biased upward, though probably by less that the CPI in light of PCE' measure's advabtages cited above. Although increases in energy proces have pushed up overall consumer price inflation over the past couple of years, core inflation has been more stable."

    In case you were wondering, I find this nonsensical.


    Letter from Fed Chair Bernanke to Jim Saxton, Chair, JEC
    May 24, 2006 statement 05-24-06.pdf
    (see page 5 of PDF)

    Friday, May 26, 2006 | Permalink | Comments (29) | TrackBack (1)

    When does Risk Get Rewarded?

    John Hussman of Hussman Funds writes:

    "Among the simplest truths is that market risk tends to be unusually rewarding when market valuations are low and interest rates are falling. For example, since 1950, the S&P 500 has enjoyed total returns averaging 33.18% annually during periods when the S&P 500 price/peak earnings ratio was below 15 and both 3-month T-bill yields and 10-year Treasury yields were below their levels of 6 months earlier. Needless to say, there are a variety of ways to refine this result based on the quality of other market internals, but it's a very useful fact in itself.

    The “canonical” market bottom typically features below-average valuations, falling interest rates, new lows in some major indices on diminished trading volume, coupled with a failure of other measures to confirm the new lows, and finally, a quick high-volume reversal in breadth (usually with an explosion of advances over declines very early into a new advance)."

    That makes terrific sense to us. What about when the opppositie is true?

    "Similarly, market risk tends to be poorly rewarded when market valuations are rich and interest rates are rising. Since 1950, the S&P 500 has achieved total returns averaging just 3.50% annually during periods when the S&P 500 price/peak earnings ratio was above 15 and both 3-month T-bill yields and 10-year Treasury yields were above their levels of 6 months earlier. Again, there are a variety of ways to refine this result, but note that anytime the total return on the S&P 500 is less than risk-free interest rates, a hedged investment position increases overall returns (since hedging instruments are priced to include implied interest).

    The “canonical” market peak typically features rich valuations, rising interest rates, often a reasonably extended and “flattish” period where, despite marginal new highs, momentum has gradually faded while internal divergences have widened, and finally, an abrupt reversal in leadership, from a preponderance of new highs over new lows (both generally large in number) to a preponderance of new lows over new highs, with the reversal often occurring over a period of just a week or two."

    Again, perfectly reasonable analysis borne out by the data. So where does that elave us at present? Consider the following:

    "Though our investment position doesn't by any means rely on it, my impression is that recent market conditions fall very much into that description of a canonical peak...

    It doesn't help the case for stocks to argue that, for example, earnings growth is still positive, because it turns out that the year-to-year correlation between stock returns and earnings growth is almost exactly zero. It doesn't help to argue that consumer confidence is still high, because consumer confidence is actually a contrary indicator, as are capacity utilization, the ISM figures, and other factors being used for bullish fodder. It doesn't help to argue that the Fed will stop tightening soon, because the end of a tightening cycle has historically been followed by below-average returns for about 18 months. It doesn't help that 10-year bond yields are still lower than the prospective operating earnings yield on the S&P 500 (the “Fed Model”), not only because the model is built on an omitted variables bias (see the August 22 2005 comment), but also because the model statistically underperforms a simpler rule that says “get in when stock yields are high and interest rates are falling, and get out when the reverse is true.”

    Good stuff, John.


    via WSJ Marketbeat


    Textbook Warnings
    John P. Hussman, Ph.D.
    Hussman Funds, May 22, 2006

    Wednesday, May 24, 2006 | Permalink | Comments (11) | TrackBack (0)

    Bernanke admits a 'lapse'

    Interesting admission from Fed Chair Ben Bernanke:

    "Federal Reserve Chairman Ben Bernanke admitted Tuesday to Congress that he made a mistake talking to a television reporter about market perception of his inflation-fighting credentials.

    Bernanke appeared before the Senate Banking Committee to talk about the relatively non-controversial topic of the need for financial literacy in the American public.

    While most of the questions from senators focused on that topic, Sen. Jim Bunning, R-Ky., a critic of the chairman, questioned him about his comments to a television reporter at the White House Correspondents' Association dinner April 29.

    "I warned you to be careful about what you say because people would follow what you said very closely," Bunning said. Markets fell after Bernanke's comments were reported the following Monday.

    After Bunning asked him if he learned anything from the experience, Bernanke said: "That episode was a lapse of judgment on my part." And he said future communication with the markets will be through established channels and testimony.


    UPDATE: May 24, 2006 6:49am

    The NYT notes Fed Chief Swears Off Improvising


    Bernanke admits a 'lapse'
    Chris Isidore, senior writer, May 23, 2006: 12:49 PM EDT

    Fed Chief Swears Off Improvising
    NYT, May 24, 2006

    Tuesday, May 23, 2006 | Permalink | Comments (20) | TrackBack (0)

    Dear God, Please stop talking about 1994-95

    Last night, the comparison came up with recent selloff action and 1987. But the more frequent relative comparison from the perma-Bullish camp is 1994. That's the year that gives some folk -- most notably, Don Hayes and James Cramer -- comfort in the belief that the market is safe from a major correction at this time.

    Ryan Fischer destroys that argument. I thought his observations on this frequent Bullish comparo between 1994 and today were  very astute. Since he does not publish anywhere else -- and I liked his piece a great deal -- I offered Ryan the Big Picture as a platform to publish this.

    As always, feel free to comment . . .

    Dear God, Please stop talking about 1994-95
    The Winds of Cost of Capital

    By Ryan Fischer, 5-20-06

    Please, please, I beg of you:  quit talking about 1994-995. 2006-07 has no similarities whatsoever -- except in your hope.

    Does anyone remember what the bond market did in 94-95? Anyone? The yield on 10 yr treasuries went from basically 5.5% at the beginning of 94 to 8% by year end. That being the number the bond market erroneously thought the FED would go to. By the end of 1995 the yield on the  10 yr was back at 5.5% a dramatic easing of financial conditions. And, on cue, assets went wild, housing and consumption caught the wind in their sails coming off the bond market and off Risk ran.

    Consider: For us to experience the same winds of easing of financial costs today yields on 10 year Treasuries (currently 5-5.2%) would have to decline to 3.5-3.7%. What kind of macro environment would we be in if 10 year Treasuries were yielding 3.5-3.7% six to twelve months from now? Hello deflationary soup!! That or some crisis that has convinced Helicopter Ben to deploy the "Unconventional Measures" he talked and wrote about during his emergence. Friends, if the Fed is buying 10 year Treasuries and causing a 3.5-3.7% yield we might as well take the stars off our flag and replace them with a hammer and sickle.

    A forewarning: Whenever you hear or read about Unconventional Measures from the Fed or the Treasury think State Interference in Free Markets. And we all know where that leads and ends.

    But, I digress, as this missive is primarily about the cost of capital, its percentage change and the effect that has on risk assets.

    Whenever you hear someone mention historically low interest rates while supporting their bullish argument for whatever risk asset they are buying, holding or selling, immediately mark them down in your book as financially illiterate. (Note, this argument is often heard from the CEOs of public builders, their real estate brethren and the sheep who follow, plus equity pushers.)

    Let me say this: It is not the absolute level of the rate of interest that matters to those who allocate capital, it is the relative rate of change.

    Let me elaborate: Everyone likes to pull the grandpa "I remember 15% interest rates in 1982, so 5% today is really historically nothing to be afraid of" (Again note; This is another favorite of anyone selling, holding or pushing real estate). Lets think about that intellectual construct for a second and see if, as a person who allocates capital, if it would sway where I push my dollars.

    Because interest rates were around 12-15% in 82-84 and today they float around 5-5.2% (ten year Treasury yields on both) I therefore should be more willing to employ my capital in risky assets because money is so much cheaper today than some 22-24 years ago.

    First, let me say I will not even touch on the subject of valuation, though the argument about then vs. now should be clear to any open seeing eyes.

    Rather, let us focus on the cost of capital. As a speculator, entrepreneur, investor, etc..etc..those absolute levels mean nothing to me. For all I care, interest rates could have been 80% in 82 and the argument about historically low interest rates today still will not sway me. In fact, I'll tell you I'm more excited about a 10%, 9%, or a 8% rate of interest in 85, 86 and 87 than I am about a 5% rate of interest in 2006.


    Its obvious, isnt it? 16% in 82 to 9% in 85 is a huge, huge tailwind at the sails of risk assets. This is a dramatic easing of financial conditions. Also, trust that asset prices failed miserably for many, many years to reflect this change. Such are the effects of psychology and the enhancing fruits of under-valuation. The world is nearly without clouds when interest rates fall so dramatically (kind of like 2000-2003). Is the world equally not dark vs. 85(15% in 82 to 9% in 85) or as sunny as 94/95 (again, 8% to 5.5%) now that rates have gone form 1% to 5% on the short end and 3.5% to 5-5.2% on the long end.

    Based on the cost of capital, when are you a buyer? When interest rates decline by 40% (15% to 9%) or increase by 45% (3.5% to 5.07%)?

    To risk assets, the cost of capital is like the wind. It is the change from the start of the race that matters, the more headwind the more trouble, and the more wind one can summon to their back, the faster the ship sails.

    God what I would give if this was the mind frame today. Imagine if after an ever bullish provocateur sighted historically low interest rates as part of their argument if the financial journalist queried them with Sir/Madam, are you saying you are more of a buyer when the cost of capital has gone from 3.5% to 5% than you are when the cost of capital has gone from 15% to 9%?  Imagine.

    But always know which way the winds of the cost of capital blow.

    -Ryan Fischer
    Red Fisch, LLC



    Ryan Fischer manages assets and capital for his family and a few private clients out of Denver, Colorado. He is long physical commercial real estate, short paper commercial real estate, long gold and short IWM. He can be reached at


    Tuesday, May 23, 2006 | Permalink | Comments (18) | TrackBack (0)

    Read It Here First: Owners' Equivalent Rent and Inflation

    Over the weekend, we discussed  the various "shills and montebanks are coming out of the woodwork to proclaim -- once again -- that there is no inflation, due to OER."

    Today's WSJ looks at that exact issue, and to Justin Lahart's credit, avoids the trap:

    Oer_20060521171210 "In other words, a hot housing market perversely depressed official inflation measures, and now a cooling housing market is pushing those measures up. Some bond investors are prepared to dismiss the statistical gymnastics. But Barclays economist Dean Maki says that would be a mistake. Price figures are simply getting back to normal after being unnaturally low for a long time, he says.

    "It would be somewhat disingenuous for policymakers to strip out owners' equivalent rent now, when they weren't stripping it out before when it was keeping core inflation low," he says."

    Disingenuous is certainly the right word for it, and kudos to Dean Maki for recognizing that.

    Incidentally, the OER still understates inflation, as the chart at right reveals. 

    In related news, after the third consecutive weak monthly LEI, the Conference Board has announced yet another change to the leading indicators. The latest adjustment? Any item showing a negative number on a given month will be multiplied by "minus one" to change the coefficeint to a positive number. A spokesman announced that "this will help keep the LEIs  as completely useless as possible."


    Gimme Shelter
    Justin Lahart   
    WSJ, May 22, 2006; Page C1

    Monday, May 22, 2006 | Permalink | Comments (14) | TrackBack (0)


    What Would Greenspan Do?

    That's the question the WSJ's Greg Ip asks:

    "Should the Fed worry more about rising inflation and raise rates further, risking a recession? Or should it worry more about growth and hold rates steady, risking higher inflation and a loss of credibility? The outlook for global stock and bond markets will hinge on the outcome of that decision."

    As if we don't know WWGD:  The short answer is, he would flood the system with liquidity. The longer answer involves opaque speechifying about systemic risks and global resilience and blah blah blah, as he released the hounds of M3 into the ether. (more money supply! Faster! Faster!)

    The column references an academic study co-authored by Bernanke  that concluded "economic growth begins to slow roughly six months after the Fed tightens monetary policy. But inflation doesn't begin to ease until about year has passed."

    The net result of this is the conundrum we referred to  last week, with the Fed painted into a corner.

    Here's an excerpt from Ip's column:

    "The result often is an uncomfortable period when growth is slowing, inflation rising and the central bank facing a tough choice between higher rates and watchful waiting.

    That may be where the U.S. economy is now. After a first-quarter surge, growth is slowing, as higher interest rates and energy prices take their toll on housing and consumer spending. It "seems pretty clear that the housing market is cooling," Mr. Bernanke said Thursday, though the slowdown is quite "orderly and moderate." But core inflation, which excludes food and energy, reached a one-year high of 2.3% in April.

    Markets have gyrated on the economic crosscurrents and bond yields reflect a rising concern about whether Mr. Bernanke will hold inflation low over the long term. "With core inflation crawling up, a new central-bank chairman is clearly not going to want to let inflation expectations go up," Mr. Gertler said.

    With the Fed having raised its short-term interest-rate target in 16 quarter-percentage-point steps to 5% since June 2004, some at the central bank appear to favor pausing soon to assess the impact of those moves on the economy."

    Today's futures look like hell (glad I got stopped out of longs last week). If we see a serious whackage today -- and it sure looks like we might -- that will resurrect the possibility of a pause in June.


    Here is everyone's favorite faulty comparison: 1994 vs 2000 vs 2005
    click for larger graphic


    Source: WSJ

    As previously noted, the better comparo is 1973.


    Trade safe today -- it looks like it could get ugly out there.


    What Would Greenspan Do? Bernanke Weighs
    Risks of Rate Increases and Rising Inflation
    WSJ, May 22, 2006; Page A2

    Monday, May 22, 2006 | Permalink | Comments (4) | TrackBack (0)

    All Aboard the Reality Express!

    Shameless plug: Last October, "The Unpleasant Truth About Inflation" noted all the reasons why inflation was actually much higher than most people (including the Economists on Wall Street) believed.

    It took market participants an astonishing 8 months to figure this out.

    Nothing much has changed except perception. Growth is still slowing, and is as Real Estate dependent as ever. Prices continue to increase, regardless of the idiotic focus on the Core rate (don't sugar coat it, tell us how you really feel). 

    What has changed from last week, when the dominant meme was Pause! to today, when the newfound fear is a Half-Point hike? Psychology. Groupthink. Emotions and sentiment.

    The only thing truly different is the Goldilocks fantasists have changed trains, and are now on the Reality Express.  Next stop: 2% GDP, 5% inflation. ALL ABOARD!

    Of course, the markets haven't liked this. Goldilocks is a fairy tale, while Reality has warts. These are consequences for decades of easy money and years of bad policy.  Like the twin deficits. Growing disparities in wealth, which will ultimately lead to spasmodic anti-capitalist legislation. Deficit producing tax cuts. Post crash damage still unresolved from 2000. A ruinous war costing treasure and lives and despoiling the United State's reputation globally. Is it any surprise the greenback has gotten kicked around like a junkyard dog? All the while these markets have been as  utterly dependent as a babe at its mother's breast on massive government stimulus for ongoing growth. My name is Mr. Market, and I am stimulus-aholic (Hi Mr. Market!)

    Keep repeating after me: Except for everything going up in price, there is no inflation . . . 

    Friday, May 19, 2006 | Permalink | Comments (32) | TrackBack (0)

    The Fed's New Conundrum: Slowing Housing

    Fed_20060510205610 Yesterday' 1/4 point rate hike was no surprise . . . but the thought processes behind it may be. Consider the conundrum left to Ben Bernanke by his predecessor, Alan Greenspan.

    Post market crash, recession, 9/11, and Iraq War, this was a flatlined economy. Anytime a major market takes a 78% whackage, huge swaths of capital gets destroyed. The Fed's response to this was to slash interest rates to half century lows.

    The initial results of this were somewhat predictable: the Housing sector accelerated and the global economy reflated. Back in December 2002 I mentioned that investors might want to watch gold due to the inflationary potential of these ultra-low rates. (Not quite the table pounding of last year, but quite timely).

    At the same time, China began building out its infrastructure in anticipation of its Olympic hosting duties. Concurrent to this was the enromosu boom in direct China investment by Western companies, all seeking to dramatically lower their costs.

    Technology companies may not be the benficiaries of this -- at least not their stock prices. The subsequent economic expansion was atypical and lumpy, unevenly distributed. Leadership came from Housing, Materials, Energy, Industrials and Transports -- not your typical bull market leaders. Noticably missing were Technology and Financials. How's this duality: Job creation was amongst the worst on record, yet profits are at the top of historical ranges. Housing drove employment, consumer spending, and sentiment.

    Then there was inflation. Despite the tortured gyrations that the BLS and Fed goes through, only the most myopic or clueless economists continue to deny the robust price increases across industrial metals, health care, housing, energy, precious metals, insurance, food, education, transportation. Indeed, the only place inflation has been well contained has been wages. 

    Since August 2005, we described what we saw as the cooling beginning in Real Estate. Yet despite this slowing, and its eventual impact on consumer spending, the same inflation pressures remain, mostly due to Globalisation and demand from Asia

    Hence, the conundrum. The Fed cannot risk allowing very apparent commodity inflation pressures to continue to rise unabated; at the same time, the end of the housing rally is clearly in site.

    This is the conundrum that led IMO, to the "Pause" line of thinking.


    200605_350x476 So where does that leave us? Pimco's Paul McCulley notes that housing related demand for credit is one of the key elements in money growth. Getting the balance right of credit and money supply versus demand, the Monetarists warn us, is a key element in keeping inflation under control. 

    Meanwhile, there is little evidence that the nation's "obsession with real estate is abating," notes the WSJ.

    The takeaway of all this comes from Harpers magazine, who may have accidentally come up with the most astute visual. Their most recent issue has an article on "The New Road to Serfdom: An illustrated guide to the coming real estate collapse."

    That's supposed to be John Q. Public shouldering the exotic interest-only no-money-down mortgage load in the graphic.

    Instead, I think that's a drawing of how Ben Bernanke must feel:  He's facing monetary pressures at home, a slowing U.S. economy as Real Estate cools, and hot global inflationary forces beyond his control short of forcing a global recession.

    A soft landing for a man shouldering that load looks increasingly unlikely.

    Source: Harpers 

    Thursday, May 11, 2006 | Permalink | Comments (49) | TrackBack (0)

    Parsing the Fed

    The original Fed statement is here;

    The WSJ Parses this statement with last month's:

    THE FED'S STATEMENTS reflect how the members of the central bank's Federal Open Market Committee perceive the economy. The slightest changes are scrutinized for clues about where interest rates may be headed. The May 10 statement announced that the Fed was raising its key short-term interest rate by one-quarter point to 5%, its 16th increase in a row and second under Bernanke -- which came as no surprise. More importantly, the statement opened the door for a halt to rising rates for the first time in two years, while not ruling out more increases. Below are the differences between the May statement and the March one.

    click for larger graphic


    Wednesday, May 10, 2006 | Permalink | Comments (9) | TrackBack (0)

    To Pause or not to Pause

    How bored am I waiting for the next Fed Statement?

    This bored:

    To Pause or not to Pause, that is the question:
    Whether 'tis nobler in the mind to suffer
    The slings and arrows of outrageous commodity prices,
    Or to take arms against a sea of rising yield troubles,
    And by opposing inflationary trends, end them?
    To halt: to stop tightening; No more; and by a tightening to say we end
    The heart-ache and the thousand natural shocks of incremental rate increases
    That Treasuries are heir to, 'tis a consummation
    Devoutly to be wish'd by equity traders. To halt, to cease;
    perchance to dream of the end of the rate cycle: ay, there's the rub;
    For in that sleep of death what dreams may come of runaway inflation
    and gold priced over $700 an ounce.
    When we have shuffled off this mortal coil *(and into the private sector),
    This must give us pause: there's the respect of bond ghouls,
    That makes calamity of markets domestic and foreign;
    For who would bear the whips and scorns of said ghouls verging on madness
    The oppressor's short selling, the proud man's margin calls,
    The pangs of despised Sarbox, the law's delay,
    The insolence of regulators and the spurn of taxes
    That patient value investors merit of the unworthy day trader takes,
    When he himself might his quietus FOMC make
    With a bare bodkin? Who would fade the bull and buy the bear?
    To grunt and sweat under a trader’s life,
    But that the dread of something after Spitzer,
    The undiscover'd buy side from whose bourn
    No broker returns, puzzles the will
    And makes us rather bear those deficit ills we have
    Than fly to slowing economic growth that we know not of?
    Thus conscience does make cowards of us all in the wake of worsening inflation expectations;
    And thus the native hue of resolution at FOMC meeting
    Is sicklied o'er with the pale cast of the steeper yield curve and greater TIPS spread,,
    And enterprises of great pith and Crude Oil
    With this regard their currents turn awry from the weaker dollar,
    And lose the name of action. – Softer rates you now say!
    The fair Ophelia! Nymph, in thy orisons and increased demand for inflation-protected securities,
    Be all my sins remember'd.

    To be, or not to be (from Hamlet 3/1)

    With my deepest apologies to William Shakespeare 

    Wednesday, May 10, 2006 | Permalink | Comments (20) | TrackBack (1)

    Chart of the Week: Market Performance pre and post-Fed

    Mike Panzner observes:   "Over the course of the current tightening cycle (comprised of 15 rate hikes beginning in June 2004), the median return for the S&P 500 on the day of an FOMC rate hike has been a loss of 0.09%,  while the median return for the day after has been a gain of 0.19%.

    The best performing group on the day of a rate hike has been the Consumer Discretionary sector, with a median gain of 0.31%, while the worst performing group has been Information Technology, with a median loss of 0.23%.  On the day after the hike, the best performing group has been the Energy sector,  with a median gain of 0.73%, while the worst performing group has been the Industrials, with a median loss of 0.06%

    Market Performance pre + post-Fed


    Source:  Mike Panzner


    Information Technology, Industrials, and Financials have been in the bottom four (out of 10) groups on both days, while the only sector that has been in the top four on both days is Consumer Staples.

    One interesting observation: while the median return for the S&P 500 has been a small negative, only one group, Information Technology, has a median that is less than zero. Logically, that sounds wrong, but it may simply add weight to the anecdotal observation that FOMC rate days tend to be a little chaotic, with some sectors moving more sharply than others.


    Random Items:

    Asia Is Getting Ready to Dump the Dollar Peg

    Will The Markets and The WSJ Let Ben Be Ben? (pdf)

    A Chill Is in the Air for Sellers

    The Immigrant Economy

    Fed 'Pause' Won't Be End of Story       

    Analyst Mary Meeker is back and looking awfully average

    New Iraq strategy:  Muddle through until the end of 2008, then its someone else’s problem

    Quote of the Day

    “I measure what’s going on, and I adapt to it. I try to get my ego out of the way. The market is smarter than I am so I bend." 
    -Martin Zweig

    Tuesday, May 09, 2006 | Permalink | Comments (1) | TrackBack (0)

    Rising Inflation is a Bigger Tax Bite than Oil

    “Rising Oil prices are like a tax.” 

    I’ve heard that canard repeatedly over the years. There are lots of reasons why this is not quite true – unlike a tax, lots of petrodollars leave the country, and don’t get recirculated. However, high Oil prices are a drag on very specific types of consumptive activity: driving, traveling, manufacturing, home heating are the prime endeavors that get curtailed.

    Inflation is a much more pernicious a “Tax” than Oil – and on more kinds of economic activity. The ongoing reduction of the dollar’s purchasing power (a/k/a inflation) impacts much more of the economy than even energy price increases do. Consider high energy prices are merely one aspect of inflation. Everything else that rises in price – from industrial metals to insurance to housing to health care to construction materials to education to food to precious metals – impacts everything else, plus a wealth of activity that inflation acts as a tariff upon.

    High inflation taxes savings, as a dollar saved becomes only a half-a-dollar earned. Indeed, why save if all you accomplish is watching your purchasing power erode? (Perhaps this is why the savings rate has plummeted). Inflation also hurts investment, as it reduces real returns, and therefore discourages parking monies for longer periods of time.

    As we have heard so often from the politicos, if you want less of something, tax it more. Those who are willing to appease inflation and sacrifice long term purchasing power for a short term growth spurt do just that:  They discourage savings, retard investment, reduce consumption, dampen hiring. If you ask me, that’s a really bad tax policy.

    Consider a home purchased in 1970 for $100,000; If it was sold for $400,000  $514,949 today, (according to BLS Inflation calculator) the gain would merely cover inflation. In real, after-inflation terms, your returns were zero – Nada, zip, zilch, nothing. And that is why inflation is so pernicious, and why it is incumbent upon the Fed to stay on top of it, even daresay I at the risk of slowing growth.

    Ponder this: The Dow and SPX, despite reaching 5-year highs, have returned less than 5%/year over the same period. Though CPI estimates for inflation are below 5%, we know in real world terms (where we eat and use energy) these gains failed to keep up with inflation. In other words, real returns are negative versus actual – not BLS measured – inflation. Perhaps that explains why U.S. Equity markets have under-performed every other asset class and emerging market, with the lone exception being U.S. Treasuries.

    Away from inflation – or perhaps because of it – we continue to watch the markets internals slowly deteriorate: The advance decline line has not confirmed recent Dow highs; the NYSE A/D line topped out in March. Meanwhile, mutual fund cash levels are down to low levels. And, we are about to enter the seasonally weakest period of the year. We have been positioned as “uncomfortably” bullish these past few months -- our view remains first half rally, second half trouble -- and we note that these elements mean risk is rising.

    We strongly urge increased caution.


    Originally emailed 5/2/06 ~11am

    Wednesday, May 03, 2006 | Permalink | Comments (38) | TrackBack (0)

    Berry to Bartiroma re: Bernanke: Big Burn, You Blew It

    Berry_1 John Berry, the Washington Post reporter (now at Bloomberg) who covers the Fed -- and widely believed to have a direct line from Greenspan and other FOMC members -- came out swinging this morning. In today's column, he accused CNBC reporter Maria Bartiroma of "burning Bernanke," engaging in journalistic ethical lapses, and failing to treat private conversations at an off-the-record event appropriately.

    Earlier this morning, Berry wrote:

    "Federal Reserve Chairman Ben S. Bernanke wasn't cautious enough about the ground rules when he chatted with journalists at the White House Correspondent Association's dinner April 29, and he got badly burned . . .

    Virtually all reporters treat discussions at such events as being off-the-record -- that is, not for publication -- unless there is an explicit understanding otherwise. You can be sure he has learned that painful lesson."

    In other words, the veteran print journo is accusing the TV anchor of not understanding the rules of engagement when mixing at social functions with the personalities and subjects they cover. CNBC (through a spokesman) disagreed, saying "there was no question Bernanke's comments were on-the-record."

    Berry goes on to add that it was clear the Fed is "Not Finished" and that markets did misunderstand the concept of a pause; he quotes WaPo reporter Nell Henderson's column, that while the central bank may "pause in the process of raising interest rates to restrain inflation, that would not necessarily mean they were finished.''

    Reuters reported that "speaking after the markets' close on Tuesday on CNBC's "Kudlow & Company", Bartiromo said she was sure Bernanke didn't want to see major market reactions to his remarks and that "in his heart, I did him a favor."

    Several others have criticized Bartiroma for sitting on her market moving news until her 3pm show began. After she released her "scoop," the market tanked.

    Bartiroma, formerly known as the "Money Honey" for her reports from the floor of the NYSE, has generated all kinds of criticism and coverage since the snafu.

    I suspect we may not have seen the last of this story . . .


    UPDATE 2 May 4, 2006 11:48am

    Ben is a fast learner; from a friend (quoting Reuters) we see that:

    Yesterday, midday, at that local-economy talk the Fed Chief gave in DC, “When he arrived at the conference, reporters asked exactly what he had said at the dinner, but he walked by without a word. He did not take audience questions, and left as silently as he had arrived.”

    Apparently "Once bitten, twice shy" is a fair assessment of the new Fed Chief's experience with the Press. Dunno what they taught you at MIT and Harvard, Ben, but all you hadda do was call, and I woulda schooled ya on the finer points of dealing with the media.

    Now ya know.


    UPDATE 1 May 3, 2006 9:48am

    Here's a link to the video of Maria Bartiromo's 3 PM interview.

    Note: This only works with Explorer 6, and I am using IE 7; (Leave it to Microsoft)


    Bernanke Couldn't Be Clearer -- You Hear That?
    John M. Berry
    Bloomberg, May 3, 2006

    Other Coverage:

    CNBC's Bartiromo says report does Bernanke a 'favor'
    Joe Maguire
    Reuters, Tue May 2, 2006 6:01 PM ET

    Bernanke slips on Bartiromo peel
    Fallout uncertain on off-the-cuff interview as confusion reigns
    Greg Robb
    MarketWatch, 6:24 PM ET May 2, 2006

    Bernanke remarks leave analysts bemused
    Jennifer Hughes in New York
    FT May 2 2006 21:55 | Last updated: May 2 2006 21:55

    Investors Misunderstood Bernanke Testimony, CNBC Anchor Says
    Nell Henderson
    Washington Post, Tuesday, May 2, 2006; Page D03

    When The Fed Chairman Speaks, Everyone Freaks
    CBS, May 2, 2006

    Ben Bernanke Tells All to the Money Honey    

    Bernanke Boots His Rally?
    Minyanville Staff
    May 02, 2006 9:37

    Fed Struggles to Convince Markets Of Its Own Uncertainty on Rates
    WSJ, May 3, 2006; Page A1

    N.Y. Post, May 3, 2006

    Maria's Fed Minute
    Jeff Cooper
    Street Insight, 5/2/2006 7:09 AM EDT

    Wednesday, May 03, 2006 | Permalink | Comments (40) | TrackBack (3)

    "Forward-looking Guidance on Policy Has [Out]Lived its Useful Life"

    Fomc Front page WSJ story on the Fed's troubles convincing Wall Street that even it (the Fed) doesn't know when interest rate rises will end:

    "Federal Reserve is having trouble delivering a new message about how far it expects to raise interest rates: It isn't sure.

    Financial markets, having grown accustomed to the Fed telling them where rates are headed, seem unwilling to hear that new message. After nearly two years of raising rates, the Fed's efforts to convey that it isn't certain where they are headed now have been read by markets, instead, as a forecast of where it will take rates. Changing interpretations of that forecast have been roiling the markets in recent days.

    A potentially bigger problem for new Fed Chairman Ben Bernanke is that, with the latest growth data robust and inflation ticking higher, markets also seem to fear that the Fed will stop raising rates too soon. Since Mr. Bernanke talked last week on Capitol Hill about the possibility of a pause in the Fed's rate increases, bond and commodity markets have signaled increased concern about inflation.

    The next FOMC meeting is next Wednesday, and its a lock the Fed Funds Rate gets pushed up to 5%. Kremlinologists will also dissect the end-of-meeting statement for changes in adverbs and sentence structure.

    Will they say "further rate increases may be needed?"

    That's the key line that will make traders sell stocks, buy them back, sell them again, rally the markets, reverse 'em, repurchase, sell, sell short, cover and go long -- all in the span of about 45 minutes. Then they can go home.   

    After the May 10 meeting, the next FOMC get together is seven weeks away. The Journal notes "by that time, the data may make the decision clear to both the Fed and the markets." Let's hope so.

    Fed Struggles to Convince Markets Of Its Own Uncertainty on Rates
    WSJ, May 3, 2006; Page A1

    Wednesday, May 03, 2006 | Permalink | Comments (4) | TrackBack (0)

    Measuring Real-World Inflation versus Investing Returns

    Raymond James' Jeff Saut made reference earlier this week to a WSJ article from February of this year; I adapted part of that in my market comments today.

    Here's the WSJ excerpt:

    “If you have a house that you bought in 1970 for $100,000 and sold it for $400,000 today, the gain was just inflation – you made nothing. In fact, you may have lost money if you paid a 6% sales commission.” Also adding insult to the inflation-injury has been the massive decline in the purchasing power of the dollar since 1970."

    -WSJ, Quoting Garrett Thornburg of Thornburg Investment Management

    That number seemed a little light to me -- so I went to the BLS Inflation Calculator. It turns out that if you bought a home for $100,000 in 1970, it is the equivalent of $514,948.50 in 2006 dollars. 

    Still, that's a pretty astonishing number, and it makes Thornburg's point that you have to consider inflation in your expectations for performance. After all, its the real (not nominal) numbers that matter most.



    BLS Inflation Calculator

    For Long-Term Investing Plan, Measure Real-World Return
    WALL STREET JOURNAL, February 6, 2006; Page C1

    Tuesday, May 02, 2006 | Permalink | Comments (14) | TrackBack (0)

    One Two Three & Done (The Sucker Play)

    Once again, the One & Done crowd has managed to pull the PermaBull traders into a long side bet, following the spin 2 weeks ago after the March FOMC minutes were released, and last week's JEC testimony by Fed Chair Bernanke. 

    Over the weekend, Fed Chair Ben Bernanke told CNBC's Maria Bartiroma at the White House Correspondents Dinner that "No, the market did not get it right" after his recent comments.

    Once again, the One & Done play was a sucker's trade.

    What is this, the 4th or 5th time? Great Caesar's Ghost, even a puppy learns not to pee on the carpet after he gets rapped with a rolled up newspaper twice. These traders have been getting bitch-slapped around like they are Wile E. Coyote and the Fed Chair is the RoadRunner. Its astonishing that the same suckers keep coming back for the same abuse. Get some help, get into a support group for abused spouses investors.

    This does go a long way in explaining the new Fed Chair Curse -- perhaps it takes a while before the Chairs learn they are not still in Academia or where ever;  it took Greenspan a long time to learn to speak for 4 hours straight -- and say nothing. I suspect it may take Bernanke a little longer to learn the dark art of obsfucation . . .

    Monday, May 01, 2006 | Permalink | Comments (28) | TrackBack (0)

    Ben Bernanke's Inflation Targeting and Forecasting

    I made my displeasure known last week about the Pause/Resume scenario. A friend takes a slightly different tack, explaining that Fed Chair Bernanke's inflation targeting is even worse than my criticism implies.

    Why? As I explained in the Folly of Forecasting, predicting the future is something we Humans are particularly bad at.  And that's what inflation targeting requires:  getting the projected inflation rate right. 

    Which raises the question as to whether "Gentle Ben" might be better at it than "Easy Al." Don't bet on it; here's what Beranke said in January 2004 about Oil and Gold: 

    "Two specific commodity prices that often command attention are the prices of gold and crude petroleum. The price of gold has increased roughly 60 percent since its low in April 2001, from about $255 per ounce to about $410 per ounce. A portion of that increase simply reflects dollar depreciation, which I will discuss momentarily. Gold also represents a safe haven investment, however, and I agree that there have been periods in the past when the fear that drove investors into gold was the fear of inflation. But gold prices also respond to geopolitical tensions; these tensions have certainly heightened since 2001 and, in my view, can account for the bulk of the recent increase in the real price of gold.

    Oil prices are relatively high, in the range of $33/barrel, but they have been elevated for most of the past four years, despite a broadly disinflationary environment. According to futures markets, oil prices are expected to decline gradually over the next two years, despite accelerating economic activity, as new supplies are brought on line. Of course, there is considerable uncertainty about what the price of oil will do, given the possibility of supply disruptions. But if it follows the course projected by the futures market, the price of oil should have a modest disinflationary effect on overall consumer prices in the next couple of years."   (emphasis added)
    -Ben Bernanke, January 4, 2004

    Remind again about the advantages of inflation targetting . . .


    Remarks by Governor Ben S. Bernanke
    At the Meetings of the American Economic Association, San Diego, California
    January 4, 2004
    Monetary Policy and the Economic Outlook: 2004

    Monday, May 01, 2006 | Permalink | Comments (13) | TrackBack (0)

    Inflation Watch

    Yesterday, based on easy Ben the inflation dove's JEC testimony, I noted that:

    "I think Gold -- and most of the commodities -- just got a whole lot sexier . . ."

    That didn't take long:  Gold miners are up 4% today, Gold (the metal) is up $18, and the Silver ETF (SLV) is up nearly 5%.

    On K&C yesterday, Larry suggested that Gold's modest pullback was a sign there was no inflation. I disagree.

    I guess you can say my views remain the same: except for all various items going up in price (oil, food, industrial metals, housing, medical, education, insurance, precious metals, wood, building supplies) there is no inflation. 

    The market is speaking loudly on the same subject today . . .

    Friday, April 28, 2006 | Permalink | Comments (22) | TrackBack (1)

    Pause/Resume Scenario Increasingly Likely

    The Markets have reversed on Fed Chair Bernanke's testimony to the JEC with his "Outlook for the U.S. Economy.".

    His speech increases the odds that "One & Done" will finally occur:  the Fed is now more likely to stop at 5.0% than I previously believed.

    The money quote:   

    "Focusing on the medium-term forecast horizon is necessary because of the lags with which monetary policy affects the economy. In my view, data arriving since the last FOMC meeting have not materially changed that assessment of the risks. In particular, even if in the Committee's judgement the risks to its objectives are not entirely balanced, at some point in the future the Committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook"

    As we previously observed, the Fed Halt is now baked into the cake; Going forward, we need to watch for what we previously viewed as the worst scenario for the markets:  The Fed appeases the markets, halts tightening, and gets behind the inflation curve. After letting inflation get away from it, they subsequently resume tightening, and its a debacle for the markets.

    On the scale of hawkish/dovish past Fed Chairs, Bernanke clearly sits near "easy Al" Greenspan end of the spectrum, and far far away from the tough Paul Volcker / William McChesney Martin inflation hawks. So much for that vaunted muscularity we were going to see.

    Ben Bernanke is now the Neville Chamberlain of Inflation Fighters . . .

    I think Gold -- and most of the commodities -- just got a whole lot sexier . . .

    Thursday, April 27, 2006 | Permalink | Comments (38) | TrackBack (1)

    "Every Change of Rate"

    "Every Change of Rate" is an utterly hysterical parody of the black & white Police video "Every Breath You Take," as done by some Columbia Biz School students; Its an amusing take on the Ben Bernanke, the newly appointed Fed Chief.

    My favorite bit are the lyrics during the second verse:

    "First you move your lips,
    Hike a few more bips,
    When demand then dips,
    And the Yield Curve Flips
    I'll be watching you"

    Too funny !

    click for Windows Media video



    Its a bit harsh on Ben Bernanke, who after all has only been in office for one FOMC meeting. Still, the overall effect is quite amusing!

    Here's the video source:


    UPDATE: April 26, 2006 4:15pm

    The WSJ's Marketbeat was just as amused as I was by this:

    Glenn Hubbard: King of Pain

    Today's best four minutes of the day: an uproarious parody of the Police's "Every Breath You Take" by students at Columbia Business School, which purports to show the school's dean, Glenn Hubbard -- and, no, that is not Mr. Hubbard, the school confirms, but a look-alike student -- taking Fed Chairman Ben Bernanke to task for monetary policy mistakes (in a fit of jealousy over not getting the position). It's hard to resist the charm of any attempt to poke at the Fed, especially one that includes the couplet "Hope your models break/bet that beard is fake." The real Mr. Hubbard was traveling and could not be reached for comment.

    Wednesday, April 26, 2006 | Permalink | Comments (8) | TrackBack (4)

    Existing Home Sales Data (California Real Estate: On Sale!)

    Sales of existing homes surprised to the upside yesterday. But one data point does not make a trend. This is the first rise (sequential monthly change) after 5 straight months of falling Home Sales. And that's before we examine the data.

    Before you declare the end of the housing slow down, consider:

    - Existing Home sales actually slipped vs. last year by -0.7%; The reported gain was over last month's data;

    - the Inventory of unsold homes soared 7 percent in March, hittting an all-time record; There are now 3.19 million existing homes for sale, or  5.5 months' supply; That's the largest inventory since July 1998

    - Existing homes edged up 0.3% last month to a seasonally adjusted annual rate of 6.92 million units; (we know that seasonally adjusted data is not always accurate)

    - Year over year, the Northeast and Midwest gained, while the previously hot housing markets in the South and the West slipped;

    - median home prices are still rising, albeit nmore slowly -- up 7.4% year over year, to $218,000.

    Here's a data point that has me scratching my head:  Why are there different numbers for the year-over-year changes for seasonally and not seasonally adjusted?  Was this March somehow in a different season than last year's March? I am perplexed.

    Note that data for existing home sales comes from National Association of Realtors, a group that is certainly an interested party; Of course, as a homeowner, investor, and someone with a public bearish tilt for the second half, I'm hardly objective myself (hey, I try). But this oddity -- down -0.5% for the not seasonally adjusted year over year versus down -0.7% for the seasonally adjusted year over year -- is beyond my comprehension.

    So much for the hard data on existing sales; Today, we get New Home Sales. Recall our prior admonishments that monthly New Home Sales Data are unreliable; look instead to a moving average.

    Let's move onto some anecdotal evidence.  A friend writes:

    "Flop! Wow, KB running blue light specials in California. Not surprising, Chico area was rated one of the most overvalued markets in the country. Houses in the $200k space.  When was the last time you saw that in California? "

    Oak Knoll Place Live Oak, CA
    Oak Knoll Place Slideshow

    Here's the sales pitch:

    "Oak Knoll Place in Live Oak is located in a beautiful community near the majestic Sutter Buttes. With easy access to Highway 99, it is ideally located for easy access to Sacramento, Lake Tahoe, Reno and a wide variety of recreational opportunities. Yuba City and Marysville are approximately 10 minutes south, Chico is approximately 35 miles north and the Gray Lodge Wildlife area is approximately 10 minutes west. Live Oak has a quaint, small-town atmosphere with many nearby recreational water activities, including the Feather River, Yuba River and Sacramento River. Prices starting from the High $200's."

    I don't know Live Oak, but houses like that in California are hard to imgaine . . .

    More after the jump.

    Existing-Home Sales Rise Again in March
    WASHINGTON (April 25, 2006)

    Existing Home Sales  data


    Here's another example of price cutting on New Home Sales:

    25 new homes ready for move-in. 25 incredible values
    One weekend to see it all.
    Saturday, April 29, and Sunday, April 30, 10 a.m to 7 p.m.

    The biggest homebuying event of the season is here! KB Home is holding open houses at 25 new homes ready for move-in. Tour as many homes as you like and get friendly, personalized service. With a variety of neighborhoods, styles, and prices from the $300s, there's incredible value waiting for every new homebuyer.

    You'll also get a $10 Target GiftCard just for stopping by. And if you purchase a ready-for-move-in home during the KB Home 48-Hour House Hunt, you'll get a $1,000 Target GiftCard.

    This amazing event features homes from 7 KB Home communities throughout the greater Sacramento region. The homes are priced from the $300s, and many have great features already built in, including:

    • brand-name appliances
    • hardwood and tile flooring
    • large kitchen islands
    • master bath retreats
    • upgraded backyard landscaping

    Don't miss this opportunity to see all of our open houses in one weekend! For detailed 48-Hour House Hunt listings, click here.

    Participating KB Home communities include:
    LIVE OAK -- Oak Knoll Place
    OLIVEHURST -- River Glen
    PLUMAS LAKE -- Cobblestone
    SACRAMENTO -- The Hamptons Montauk
    SACRAMENTO -- The Hamptons Stonybrook
    SACRAMENTO -- The Hamptons Westbury
    YUBA CITY -- Walnut Park Estates

    Spend a 1/2 million dollars, get a Target gift card!

    Wednesday, April 26, 2006 | Permalink | Comments (26) | TrackBack (1)

    More evidence: Fed Pause Not Good For Stocks

    Back in February, we noted the Ned Davis Study that concluded once the Fed hikes stop, markets fall. Then this week, we looked at Investech Research's table of what happened in the past after the final Discount Rate hike.

    Today, Birinyi Associates' Ticker Sense brings us the third part of the trilogy, asking whether the Fed Pause is Good For Stocks. They did this by creating a composite of what all the post Fed tightening cycles looked like -- from the last hike to the first cut -- since 1962:


    click for larger chart



    That's a pretty compelling argument, and is consistent with our prior discussions of casuation and correlation (i.e., past Fed Cycles end when the economy shows signs of slowing).

    Note the eupohria leads to an initial 1% or so relief rally, that gives way to an 8% average drop, a 4% bounce, and then a revisit to the lows.

    Birinyi Associates notes:

    "In the Inverted Yield Curve ~ The End of The Cycle, we analyzed prior Fed rate tightening cycles since 1962. Among our findings was that in the period spanning the Fed's last rate hike to its first cut (average span of six months), the market has an average decline of nearly 7%, and has only risen during two of the nine periods. In the chart (above), we created a composite chart of the S&P 500's performance during the 'limbo' period of Fed tightening cycles.

    Here's their actual numbers:



    The two exceptions -- 1989 and 1995 -- were smack dab in the middle of an 18 year secular bull market. 1987 was brutal (but unusual), and my work suggests we are closer to the 1973-74 era.

    Thanks guys, fascinating stuff.


    UPDATE April 22, 2006 8:13am

    The chart is in this week's Barron's -- the Up and Down Wall Street Column - Bull Market in Bull by Randall W. Forsyth

    Congrats guys!



    Fed Pause Good For Stocks?
    Paul Hickey and Justin Walters
    Ticker Sense, April 19, 2006

    Saturday, April 22, 2006 | Permalink | Comments (7) | TrackBack (0)

    Smackdown: Fleckenstein vs Yardeni

    Interesting smackdown between Bill Fleckenstein and Ed "Y2K" Yardeni:"

    "Even if the Fed can't strip the inflation measurement of all items going up in price, it has a built-in excuse, provided recently by economist Ed Yardeni: One must decide whether prices are going up because of "excess demand" or supply disruptions. As Yardeni wrote in his morning piece April 11: "Raising interest rates when supply shocks may be the main reason for higher commodity prices could be a mistake, especially when there is no evidence that core-inflation rates are rising too."

    Got that?

    His explanation: "Rising commodity prices resulting from supply disruptions -- rather than driven by demand -- may take the steam out of the global boom, and slow U.S. consumer spending and overall economic growth."

    See? Rising prices will correct themselves if they're due to supply disruption, an argument that he leans toward. (Rising prices couldn't possibly come from too much money-printing, could they?) The Fed need do nothing. Thus, I believe (for not just this reason, but others that I have articulated) that only one more rate hike remains in the Fed's quiver.

    That said, I still think we could see data that would persuade the Fed not to even give us that much. If there is a nasty sell-off into earnings season, if we do in fact see some negative economic data, coupled with problems in the real-estate market (none of which would shock me), the Fed might be inclined to stand down on May 10. Either way, the rally that we get when the Fed decides it's done will be the last one before serious downside action occurs.

    Good stuff!


    Does the Fed really 'know' what’s going on?
    Bill Fleckenstein
    MSN Contrarian Chronicles,  4/17/2006

    Friday, April 21, 2006 | Permalink | Comments (18) | TrackBack (0)

    After Final Discount Rate Hike

    Todd Buchholz was on CNBC this morning. I have recommended his book "New Ideas from Dead Economists" in the past. He may be a good decent economist, but he offers investment advice that is historically unsupportable.

    Specifically, this morning he made this statement :

    "Every money manager in the country has a little file. It says what to do when the Fed says we're done. And there's only one word in that file. Ands its says 'Buy. Buy stocks, buy bonds.' "

    Buchholz is a recent (former) White House advisor, so that in part explains the cheerleading. But his clever "Join the Crowd" way phrasing things has an emotional appeal. However, the statement he made it is less than factually accurate (and it certainly isn't precise).

    Why? Because numerous studies have revealed that sustained institutional buying is NOT what actually occurs after the Fed finishes their rate hiking cycle. At leats, not in most cases.   

    In February, we discussed the Ned Davis Research study on post Fed cycle markets. NDR determined that since 1929, the Standard & Poor's 500 was actually lower six months after the last rate increase 71% of the time, and down 64% of the time 12 months later.

    As we noted earlier, bulls (like Buchholz) are now expecting an all-clear signal from the Fed. That is far from a sure thing. Ed Clissold, senior global analyst at Ned Davis Research, observed: "There's quite a bit of talk about the market doing better once the Fed stops. However, more often than not the market has struggled after the last rate hike."

    This thesis has been confirmed by Investech Research. In the majority of past Fed tightening cycles, stock prices were lower six months after the final rate hike:


    Source: Investech Research


    In 10 out of 14 occurences, markets were appreciably lower 6 months later. 2 of the 4 periods where markets did not sell off -- 1989 and 1995 -- were smack in the middle of major secular Bullmarkets. In 3 of those 4 cases, the Fed had hiked only 4 times or less.

    As Mark Twain was reputed to say, "History doesn't repeat -- but it rhymes."

    The question for those who like to study these historical precedents is simply this:  Are we in a situation similar to 1980, where 6 months after the last of 14 hikes the SPX was 8% higher? Or, is another era more analogous -- 1931, 1957 or even 2000?

    Wednesday, April 19, 2006 | Permalink | Comments (13) | TrackBack (1)

    Fed Halt Now Baked into the Cake

    Yesterday's moonshot was a marvelous thing to behold. The market took off on soft PPI and housing data, lit the second stage boosters on Janet Yellen's dovish comments, and then kicked in the afterburners on the Fed minutes.

    Still, these one day wonders have not been long lasting over the past few years. The rally on Tuesday smacked of panic buying, with shorts scrambling to cover and longs pressing their bets. It was not what one would call a day of quiet contemplation on Wall Street. Panic -- in either buying or selling -- is rarely rewarded in the markets.

    Yesterday's gains brought most indices back over their first week highs, with the NDX and the Dow Utilities as the notable exceptions.

    The net net results are twofold: First, the market has (once again) priced in the end of the tightening cycle. This is now the fourth such rally based on the "end" of the Fed Cycle. Each of the prior "One & Done" rallies have failed, as the Fed has continued to tighten.

    Second, the good news is now mostly baked into the cake. This now sets up Markets for two potentially disappointing scenarios:  One, the Fed doesn't stop at 5% (watch the June FOMC meeting). Two, the Fed pauses -- but being "data dependent," is then forced to resume tightening by the continued broad price rises driven by Chinese demand and excess global liquidity.

    I view this Pause/Resume scenario as the most perilous for the markets. It paints Bernanke (so much for muscularity) as a dovish appeaser of equity markets. Even worse, it will give the markets paroxysms. The most damaging Pause/Resume situation that occurs is more commodity driven inflation forcing the Fed's hand, while higher energy prices and slowing real estate pinch the consumer.

    Finally, it is quite revealing how atypically dependent this economy and market actually are on government stimulus:  Money supply increases, deficit spending, tax cuts, and of course, ultra low interest rates are the drivers here -- not organic growth.


    As we have discussed previously, in the past the last Fed hike has not been a market friendly event -- I'll have more on this later. Its a classic issue of confusing causation with correlation. Everyone likes low interest rates, and associates that with stimulus. But the end of the rate hiking cycle will occur when the Fed sees the expansion phase of the economy ending. And in most cases, when economic expansion ends, often Bull Markets do too.

    Stay tuned . . .

    Wednesday, April 19, 2006 | Permalink | Comments (10) | TrackBack (1)

    Fed Minutes

    The Minutes of the FOMC meeting of March 27-28, 2006  were just released. The money quotes show up towards the end (about 4th to last para):

    For the "One and Done" crowd:

    "Most members thought that the end of the tightening process was likely to be near, and some expressed concerns about the dangers of tightening too much, given the lags in the effects of policy." 

    For the "More tightening to come" crowd:

    "However, members also recognized that in current circumstances, checking upside risks to inflation was important to sustaining good economic performance. The need for further policy firming would be determined by the implications of incoming information for future activity and inflation."

    The Fed Minutes note that:

    -economic activity was expanding strongly in the first quarter;
    -Consumer spending was on track to rise at a robust pace;
    -business purchases of equipment and software picked up appreciably;
    -Warm weather boosted housing construction in January and February;
    -Private payrolls advanced solidly;
    -Headline consumer price inflation jumped in January but moderated in February as energy prices moved down.
    -Core inflation remained contained.
    -sales of new homes dropped;
    -house prices decelerated slightly
    -Labor demand continued to increase;
    -employment growth was especially brisk in the construction;
    -the average workweek edged down in February;
    -aggregate hours for production and nonsupervisory workers were above Q4 avg;
    -unemployment rate continued to decline and averaged 4¾ percent;
    -Consumer spending appeared to have rebounded strongly in Q1;
    -consumption spending was robust, supported by advances in wage and salary income;
    -Consumer confidence remained consistent with moderate increases in consumer spending;
    -Housing activity moderated somewhat;
    -Sales of new homes fell in the first two months of the year;
    -Inventory of homes for sale was elevated compared with its range of the last several years.
    -Mortgage applications continued to decline;
    -rising mortgage rates damped demand;

    Conclusion: The equity market has clearly focused on the phrase: "Most members thought that the end of the tightening process was likely to be near."

    We remain as data dependent as ever . . .


    Minutes of the Federal Open Market Committee
    Federal Reserve, March 27-28, 2006

    Tuesday, April 18, 2006 | Permalink | Comments (27) | TrackBack (0)

    One Last Comment on M3

    We started beating the M3 drum back in November 2005. It seemed to us -- on the basis of the rapid increase in M3 versus M2 alone -- it was a worthwhile stat to keep around, and we could not understand why the Fed was so intent on cancelling M3 reporting. These perspectives were dismissed by some as paranoia.

    You can imagine how pleasantly surprised we were when Raymond James' Jeff Saut addressed that very issue this morning:

    "Yet, we just don’t “get it” because as the Fed has been raising interest rates, it has simultaneously been talking rates down by commenting on how “contained” inflation remains. Surprisingly, concurrent with the Fed’s financial tightening has been Mr. Bernanke’s “printing press” gone wild with roughly $1.5 trillion additional dollars per year being added to the country’s money supply, at least at the last M3 reading. And that caused one savvy seer to exclaim, “Can you spell liquidity?!” Liquidity indeed, for as Ed Hyman aptly notes, “U.S. Federal outlays in the 4Q increased to a remarkable $2.7 trillion. That’s 21% of GDP and increasing at a 30% annual rate.”

    Suspiciously, however, one month ago those M3, broad-based, money supply figures ceased to be reported because they allegedly added little additional value to the M2 figures. Hereto “we just don’t get it” because M3 contained the amount of repo activity in the banking system while the M2 report does not. Repos, ladies and gentlemen, is short for repurchase agreements, which are contracts for the sale and future repurchase of a financial asset. Most often repos are used with Treasury securities. We think repo activity is pretty important since it shows the amount of “financial leverage” the Federal Reserve is attempting to introduce into the banking and brokerage system. Indeed, we just don’t “get it.”

    Nevertheless, in this business what you see is what you get, which reminds us of that old Annapolis “saw” – you can’t change the wind, but you can always adjust the sails! And currently the “winds” are blowing interest rates higher. Where this rate-rise will end is unknowable. Even the Fed has hinted that it doesn’t know by commenting that things are “data dependent.” However, consider this – When was the last time the Federal Reserve stopped raising interest rates with many of the equity markets at (or near) all-time highs, base and precious metals at multi-decade highs, oil within “spitting distance” of record highs, and retail sales (despite a late Easter), as well as the housing figures, stubbornly perky? Furthermore, the recent unemployment rate was at a four-year low (4.7%), while the first quarter’s employment figures showed the strongest non-farm payroll growth in six years. Historically, rising employment growth has tended to lead to rising wage pressures. As the good folks at the GaveKal organization opine, “Once again, we find ourselves asking the question, can the Fed really stop at 5% in this environment?”

    In addition to these questions, we would suggest that forgetting the laughable “core” inflation figures (ex-food/energy), annualizing last month’s headline CPI figure of +0.7% (core was +0.2%) yields an inflationary ramp-rate of 8.4% (0.7% x 12). While clearly one month does not make a trend, even if we use this week’s estimated headline CPI number of +0.4% (-0.2%E core), and average it with last month’s (0.7% + 0.4% / 2 x 12 = 6.6%), we get an annualized inflation rate of 6.6%. The potential inference from this is that despite the Fed’s “tightening campaign” with Fed Funds at 4.75%, overlaid with a 6%+ inflation rate, we could still be in a negative “real” interest rate environment. Given the possibility of still “free money” (aka negative real rates), no wonder speculation remains rampant in the various markets."

    What more can we add to that?



    The 5% Solution
    Jeffrey Saut
    Investment Strategy

    Monday, April 17, 2006 | Permalink | Comments (9) | TrackBack (0)

    Mortgages, Foreclosures & the Fed

    The WSJ discusses one of the nasty side effects on Mortgages and Real Estate of rising rates and slowing real estate: Delinquencies and foreclosures:

    "As home-price appreciation has tapered off and mortgage rates have risen, foreclosures have started to pick up, with the Midwest region hit hardest.

    Yield_curveThe rate of foreclosure -- the process by which banks can ultimately take back the properties that secure mortgages -- is a key indicator that real-estate analysts and investors use as a signal of market distress.

    In the past several years, foreclosures across the U.S. have been hovering around historically low levels, as home prices have risen nearly 50% in five years. This appreciation enabled borrowers to sell their homes relatively easily to resolve mortgage difficulties.

    Now, a survey of the latest data confirms, that is starting to change, with an uptick across the U.S. in foreclosure rates and mortgage delinquencies (or late mortgage payments). But even the new higher rates of foreclosure and delinquencies are still low in historic terms.

    Nationally, the number of mortgage loans that entered some stage of foreclosure rose to 117,259 in February, up 68% from the same month a year earlier, according to Irvine, Calif., online foreclosure-data service RealtyTrac.

    Delinquencies are up as well. Data provider LoanPerformance, a subsidiary of First American Real Estate Solutions, reported that 3% of the most vulnerable loans -- those made to borrowers with less than a stellar credit history -- were 90 days delinquent in February. That is up from 2.84% in February 2005. Meanwhile, 90-day delinquencies for loans made to borrowers with better credit were up to 0.76% in February, from 0.67% a year earlier."  (emphasis added)

    Getting the blame for the uptick in delinquencies is the "greater prevalence of riskier adjustable-rate and subprime mortgages, as well as higher interest rates and energy costs." 

    Surprisingly, the Midwest is the region with highest rates of loan foreclosures and delinquencies:  the big three are Indiana, Ohio and Michigan. One must suspect the fallout from GM is to blame in part.

    Then, there is the uptick in treasury yields. Higher rates are not a blessing in disguise --despite what you may have read by Charles "Whoopee-higher-rates-are-here-again" Biderman.

    Foreclosures Pick Up With Midwest Hardest Hit

    April 14, 2006; Page A8

    See also

    Mortgage-Bond Market Stays Strong
    WSJ, April 14, 2006; Page B5

    As Markets Bet on Rate Increases, Fed Officials Seem Less Committed
    April 14, 2006; Page A1

    Saturday, April 15, 2006 | Permalink | Comments (6) | TrackBack (0)

    Do We Have Inflation?

    Barron's jumps on the "We Have Inflation" bandwagon this week, with two editorials acknowledging what Big Picture readers have long known: Inflation, undermeasured by the BLS, is robust and widespread throughout the economy.

    Mike Santoli (subbing for Alan Abelson) addresses the subject in the front of the weekly:

    "THE COST OF AMERICA'S PASTIMES KEEPS RISING. This is not just a reference to the persistent escalation of prices for Major League Baseball tickets this season, which are up 5.4% on average from 2005, a rate of increase well ahead of that reflected in government-sanctioned inflation data.

    The trend in baseball tickets, incidentally, follows a broader pattern in today's economy. Namely, the things that we need -- gasoline, coal, health insurance, tickets for the Red Sox and Yankees -- are high and getting more expensive, while things we could easily do without -- a third flat-screen TV, another Chevy Tahoe to replace the one GM gave us in '04, fast-food burgers, box seats to a Royals game -- are relatively cheap or dropping in price.

    No, other pastimes are feeling the cost squeeze as well. A Nascar race car gets around four to six miles per gallon, about the same as the Class A RVs that so many race fans pilot to follow the circuit around the country all summer. With gasoline prices at retail up 18% from a year earlier and climbing toward the $3-a-gallon level reached last fall, this is becoming an increasingly pricey hobby. Note, not coincidentally, that nationwide registrations of motor homes fell 26% in January from a year earlier.

    Perhaps it's only a matter of time before the rocketing prices of aluminum (up 40% since September to an 18-year high) and titanium (which quadrupled in price last year) make it much more expensive for weekend warriors on baseball fields and golf courses to buy a new weapon to swing.

    Arguably the most broadly pursued pastime in the country that's becoming pricier is borrowing money, specifically borrowing to buy houses. With the bearish turn in the Treasury market driving the 10-year note yield above 5% last week, near a four-year high, Freddie Mac's benchmark 30-year fixed-mortgage rate rose to just below 6.5%." (emphasis added)

    Weighing in from the paper's end pages: Thomas Donlan (Do We Have Inflation?), who admonishes investors to be "keenly aware of inflation, and of the various methods for calculating it." That means understanding the oddities and permutations that go into the perenial under-measurement of inflation:

    "The mathematicians at the federal Bureau of Labor Statistics seemed to confirm the homeowners' intuition: The index most used to measure the rise of consumer prices (Consumer Price Index for All Urban Consumers) was up 3.4% in 2005, and the price of shelter, whether rented or incorporated in the price of a home, was up 2.6%. The appreciation of homes as investment assets was over 20% in some places. But investment isn't consumption, and so investment assets aren't recognized in the CPI. The statisticians confirmed that homeowners were wealthier, but only by definition.

    Even within the realm of consumer goods and services, prices often respond to supply and demand more strongly than to the price of money. Gasoline was another hot topic last year. The price was up 50% between September 2004 and September 2005. Since gasoline is a commodity that almost every American buys every week at a price that's clearly advertised in front of every gas station, many Americans use it as a simple proxy for the cost of living. Such people had the feeling last year that inflation was rising fast."

    We've discussed all too many times that CPI fails to adequately capture the perniciousness of rising prices as they are experienced by consumer and corporations alike. Donlan observes "Like it or not, we are stuck with measuring inflation by measuring prices. But we must understand that the measurements are made with a rubber yardstick."

    Ironic. Just as inflation -- and the absurdity of the CPI -- is finally get the ink it deserves, the acceleration in inflation has begun cooling off.

    Oh, we still have inflation, only its not getting worse at a faster clip anymore.


    Cheapening Luxuries
    Barron's, April 17, 2006

    Do We Have Inflation?
    Barron's, April 17, 2006

    Saturday, April 15, 2006 | Permalink | Comments (37) | TrackBack (0)

    Will the US Economy Decelerate Rapidly as Boomers Retire?



    Bloomberg reports that a "Revolutionary" Federal Reserve study is "shaking economists' forecasts by suggesting the U.S. economy will have to decelerate much more over the next decade than most now expect."

    The study won't be out until July (we referenced it last week here) and was drafted by Stephanie Aaronson, Bruce Fallick, Andrew Figura, Jonathan Pingle and William Wascher.

    What makes the study so controversial is that the "retirement of the Baby Boom generation will force far-reaching adjustments in the way the economy works. Forecasts for everything from growth and employment to corporate profits and interest rates will have to be recast."

    From the Bloomberg column:

    The study projects a slower pace of workforce growth than most economists now forecast, suggesting the economy can't keep growing at the present-day pace without generating pressure for higher wages and inflation. To prevent that, the Fed will have to enforce a lower speed limit on the economy by pushing up interest rates.

    The study suggests that growth over the next 10 years will average less than 3 percent, instead of the 3.3 percent of the last decade, economists said. A 0.3 percentage point difference in growth in the $12 trillion U.S. economy translates into $360 billion over 10 years, equal to the size of Switzerland's economy. Payroll gains, which averaged 200,000 a month in the 1990s, may be half that.

    ``This is a very big story,'' said Laurence Meyer, vice chairman of Macroeconomic Advisers LLC and a former Fed governor. ``It makes the challenge for the Fed a little greater.''

    The study also conservatively projects a "3 percentage-point decline over the next 10 years in the labor force participation rate." (We've been discussing the drop in the  the percentage of people working or looking for work for some time now).

    As the participation rate drops, so to will the Growth Rate slow. Labor force growth will slow, as will hours worked.

    What makes this so significant is the that the Fed Study estimates are "well below current government and private forecasts." This will impact everything from Federal Deficits to Social Security.




    'Revolutionary' Fed Study Has Economists Rethinking Forecasts
    Carlos Torres, Rich Miller
    April 13, 2006 00:10 EDT

    The Recent Decline in Labor Force Participation and its Implications for Potential Labor Supply
    Stephanie Aaronson, Bruce Fallick, Andrew Figura, Jonathan Pingle, and William Wascher
    Division of Research and Statistics, Board of Governors of the Federal Reserve System
    March 2006, Preliminary Draft

    Thursday, April 13, 2006 | Permalink | Comments (36) | TrackBack (2)

    Chart of the Week: Yield Curve, 2002 versus 2006

    In 2002, the Yield Curve was extremely steep, with short term rates at half century lows. This was extremely stimulative to economic growth. Money was cheap, the carry trade was in full swing, and the Real Estate market was just beginning to accelerate.


    Yield Curve, 2002 versus 2006


    Sources: StockCharts


    In December, the yield curve was inverted, and today, it is flat. The Fed finally got its wish, with the long bond responding to increased Fed Fund rates. We wouldn’t be surprised if the curve ends up steepening as traders sell the longer dated bonds.


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    Quote of the Day: 

    “To know values is to know the meaning of the markets.”
    -Charles Dow


    Note:  This was part of a larger research piece that was emailed to institutional clients on April 11, 2006 at ~10:00am


    Wednesday, April 12, 2006 | Permalink | Comments (0) | TrackBack (0)

    Did the Yield Curve Send a "False Alarm?"

    "So much for the inverted yield curve."

    Or so says a recent Bloomberg column. If I read this correctly, any inversion that fails to cause an immediate recession is proof positive that inversions are meaningless, the bond market clueless, and data analysis of little if any value. Therefore, as an economic indicator, this must be declared null and void and immediately disposed of.

    To wit:

    "Bond yields may have sent a false alarm. The government said today that U.S. employers added 211,000 jobs in March, capping the best start for hiring of any year since 2000. Gross domestic product last quarter probably expanded at a 4.7 percent rate, the fastest in more than two years, a Bloomberg News survey shows. The Federal Reserve is talking about the need to keep raising interest rates to make sure the economy doesn't overheat."

    Let's reiterate some of our prior comments about the yield curve, and what it means for investors:

    First, any serious student of the market needs to consider the depth and duration of the inversion; That impacts what it implies for the future. As we wrote last year:

    "A brief, shallow inversion won't signal any marked slowdown in the economy.

    Over the past several decades, the yield curve has had to invert by two percentage points or more before a recession materialized."

    The longer and more inverted an inversion is, the greater the slowdown it forecasts. A short, shallow inversion is a warning; The longer it stays inverted, the greater the impact. There is a nuance to the curve that seems to be getting overlooked.

    Second, Yield curves do not take place in a vaccuum. The context and other factors involved need also to be considered, such as energy prices. And to reiterate this yet again,  one needs to consider at all times multiple variables when analyzing Markets. The context of rising oil prices and inversions is important (see the charts here for more).   

    Its worth pointing out that the yield curve is actually more than one variable; its a combination of two factors:

    First, Short interest rates, which reveal the Central Bank's economic expectations.

    And, second, its a function of long rates, which embodies the Bond Market's economic expectations.

    As we quoted in December:

    "The historical record speaks for itself," said Merrill Lynch analysts in a report published Friday.

    "In the past 30 years, the yield curve has inverted five out of the eight times the Fed has been tightening monetary policy. Each of those five times an economic recession has ensued one year later -- our fear (though not our base case) is that this time will be no different."    - Marketwatch

    That's a year later -- not 90 days. If you want to be even more precise, the historic lead time is 40 weeks prior to a slowdown.

    Lastly, consider this chart:
    (previously shown in September '05)

    click for larger graphic


    The data looks fairly persuasive that any inversion is worth noticing, and that a longer deeper one is a broad warning sign that investors ignore at their own peril.

    Yes, we live in a bumper sticker society, where nuanced is scorned, sound bites rule, and careful contemplation is a rarity. That doesn't mean we all have to succumb to the philistines . . . 


    Yield Curve Sent False Alarm as U.S. Economy Expands
    Elizabeth Stanton
    Bloomberg, April 7, 2006 09:44

    Understanding the Inverted Yield Curve
    August 20, 2005

    Wednesday, April 12, 2006 | Permalink | Comments (10) | TrackBack (0)

    Does the US have a "Credit Risk Spread" vs Other Nations?

    Why have yields on US Treasuries been so much above other nations?

    I am not referring to the recent spurt on the 10 year towards 4.98%; Rather, I am referencing the generally higher yield on US Treasuries versus other westernized nations (UK, Canada, Germany, Japan).   

    In the past, we have seen this spread occurring in periods of elevated US risk:

    click for larger graph

    Source:  Bloomberg


    Justin Lahart notes the impact of the dollar on this process:

    Rates_comparos "U.S. stocks are getting repriced versus foreign stocks. Between 2002 and 2004, this rebalancing happened largely because the value of the dollar was declining, dragging down the value of U.S. investments. But last year, when the dollar rallied, it was through relative stock prices. U.S. stock markets simply couldn't keep up with rivals abroad.

    The same can be said of the bond market. Last year long-term U.S. Treasury securities underperformed long-term government bonds in Europe and Japan. Because bond yields move in the opposite direction of their prices, that's another way of saying that U.S. interest rates rose relative to their overseas counterparts. Today, the yield on a 10-year U.S. Treasury note, 4.79%, is higher than yields in places like Germany, the U.K. and Japan . . .

    The good news here is that Treasury bonds now provide overseas investors with better yields and U.S. stocks look cheaper relative to overseas stocks. That helps to keep attracting foreign capital. The bad news, says Mr. Prince, is that the repricing isn't finished.

    I am not sure its purely a currency issue, since it seems to persist regardless of whether the greenback is rallying or taking a dive. As the chart at top shows, it often peaks near an "event."

    I'm curious if the yield has anything to do with the geopolitics of Iraq, our twin deficits, or something else entirely.




    Losing Ground
    March 29, 2006; Page C1

    Monday, April 10, 2006 | Permalink | Comments (34) | TrackBack (0)

    NFP lifts Yields & Spooks Stocks

    Econ_20060407191808 Don't say you weren't warned.

    Yesterday's NFP data was only slightly warmer than consensus -- 211k vs 200k -- but it was enough to push the 10 year yield up to nearly 5%. That was enough to scare equity holders out of their longs, and drive the Dow down almost 100 points.

    The 5% yield is obviously troublesome from a macro perspective; Higher fixed income yields attract  investment dollars while simultaneously making operating costs higher for corporations.

    Higher yields also pressures  those consumers who have variable debt obligations -- credit cards and adjustable mortgages. And you can just about forget HELOC/Cash out refis for the near future.

    Let's address a few data points that have bveen released lately that may be in need of some further explanation:   

    1) $16.49 is the average hourly wage for production worker, who are about ~80% of the work force. That's a monthly gain of 0.2% (February was revised to +0.4%)

    2) Hourly pay is now 3.4% than 12 months ago -- that increase fails to keep up with the inflation rate

    3) But Wage improvement has accelerated in 2006. Compare an annual 2.3% rate 6 months ago versus 3.7% today; The WSJ noted "it's the first time since June 2005 that production workers saw their weekly pay rise above inflation." This explains all the recent Fed fears -- and yield gains;

    4) The total number of new hires reflect both organic growth and Katrina relocatees finally showing up in the data;

    5) Hours worked ticked up, after sliding for a while. However, many of these hours are not paid work -- they reflect (in part) non-compensated overtime; They may be less inflationary than  assumed;

    As you can see, NFP and the details beneath are a bit more complex than just the headline number.


    Payrolls Increase at a Healthy Pace Companies' March Hiring
    Hints at Upward Pressure On Inflation and Wages
    April 8, 2006; Page A3

    Saturday, April 08, 2006 | Permalink | Comments (1) | TrackBack (1)

    Giving the Fed Excuses for More Tightening

    We noted last week that the shorter term risk was to the upside. After outlining many of the technical positives of the market, we noted that modestly supportive words from Bernanke & Co. would be all it takes to light the fuse. We suggested a “more hedged stance than a naked short one,” and advised that “nimble traders can get long.”

    That turned out to be the correct short term posture. While we like to use variant perception to determine when the crowd is wrong, we know better than to fight the tape. It is always better to step off the tracks than fight a freight train speeding your way. Indeed, that short term shift kept us out of trouble (or at least out of the way) as we waited for locomotive to pass by.

    But even that shift in our trading posture underestimated the degree of denial coming from many traders and fund managers. Despite the Fed’s explicit statement that more tightening is sure to come, many market participants are still rationalizing the “One and Done” thesis as possible.

    This is roughly analogous to rooting for George Mason in [last nite’s] NCAA final between the Florida Gators and the UCLA Bruins.

    For example, Monday’s ISM reading of 55.2, down from February’s 56.7, was hardly proof of a slowing economy (Manufacturing is an increasingly smaller economically). Yet somehow, the markets overlooked the Index of Prices Paid, which climbed to 66.5 in March, up from 62.5 in February and 65 in January. This served to prove us Humans (traders included) selectively perceive only what we want to. On the ISM and prices paid data, equities extended their gains.

    In terms of Fed think, the Central Bank is now awash in excuses to keep tightening. The most recent of which was a study by a group of Fed researchers that concluded unemployment rates are not artificially low due to people dropping from the labor market. The study concluded we are at full employment, that strong job growth is likely over the next year, and that wages may rise appreciably. The Fed is likely to view this as an inflationary risk over the coming quarters. That suggests their bias will be to keep tightening, finishing in a range between with 5.5% and 6%.

    We think these researchers are incorrect. While inflation has been robust across most sectors of the economy, the one area where is not has been in wages. Globalization – and a lumpy recovery – has kept wage pressures down. Inflation-adjusted Income is negative, hours worked have slipped, and employee mobility is modest.

    We reiterate our first half targets of 11,800 on the Dow and 2600 on the Nasdaq. The topping process includes too much enthusiasm taking markets too high. That sentiment is certainly at work in current market conditions.

    (emailed April 3, 2006 noon)

    Tuesday, April 04, 2006 | Permalink | Comments (56) | TrackBack (0)

    Chart of the Week: Monthly S&P500 Gains/Losses (7 year)

    Maybe this will help explain the street’s obsession with running any and every piece of data is through a “Fed lens . . .”

    As the chart below shows, monthly gains this Fed cycle show two distinct phases: From March 2003 until the June 2004, while the Fed was either easing or held rates at 1%, the S&P's total return was 39%, or a 2.7% monthly average (in Red, below).

    Monthly S&P500 Gains/Losses (7 year)


    Sources: Barron’s and Bob Bronson

    Since then, the S&P has generated weaker returns -- about 18%, or less than 0.6% a month (in Blue, above).


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    Tuesday, April 04, 2006 | Permalink | Comments (0) | TrackBack (0)

    Fed Gets New Excuse to Keep Tightening Rates

    Short version: A group of Fed researchers presented a paper that rebuts the slack in the labor market argument. The Fed, therefore, is likely to continue its rate hikes beyond the expected 5% funds rate.

    Long version: Keep reading . . .


    In 2004 Katharine Bradbury, a Senior Economist at the Federal Reserve Bank of Boston, published research suggesting that "labor force participation rates post recession have not recovered as much as usual."

    This was an early explanation for what has been one of the weakest post-recession labor recoveries in the post-war period. (We've detailed this many times in the past).

    Last week, a different group of Federal Reserve researchers came to the opposite conclusion. This group determined "U.S. unemployment really is low and the jobless rate hasn't been artificially depressed by a failure of many discouraged workers to be counted as unemployed."

    The heart of the study wades looks at the "failure of more people to seek work since the recession ended in 2001. The "participation rate" -- the proportion of working-age people working or looking for work -- peaked at 67.3% in 2000, fell to 65.8% in March 2005, and has since recovered to 66.1%, below where it stood for most of the 1990s. (WSJ)"

    Amongst other factors, the research group noted that the hot job market of the 1990s pulled many more people into the labor pool than normal. They also blamed the "aging of the baby boom cohort" and other structural changes.

    While the group's conclusions are arguable, the more important aspect of this is that it -- incorrectly or not -- gives the Federal Reserve the ammo it needs for continuing their tightening campaign. The Fed is now fighting a ghost: a tight labor market that doesn't exist, wage inflation that actually fails to keep up with price increases, and full employment that is hardly anything of the sort.   

    This adds to the liklihood that the Fed will do what Feds typically do: tighten rates beyond what's necessary to merely cool inflation. After all, an economy with full employment, a tight labor market and rampant wage increases are the perfect growing conditons for blossoming inflation.

    If only those conditions actually existed . . .

    Nilf_wsj The WSJ notes that some analysts (present company included) believe "the low participation rate means many people aren't seeking work because they believe no desirable work is available and aren't counted as unemployed. The economists believe the unemployment rate -- which at 4.8% in February was low enough to qualify as "full employment" in many conventional views -- may mask underlying labor-market weakness. A staff study by the Federal Reserve Bank of Boston a year ago argued the unemployment rate, then about 5.4%, might understate the actual degree of unemployment by one to three percentage points."

    As the chart nearby makes clear, the participation rate has fallen dramtically since the recession.

    The employment rate is a fraction: the numerator (top number) are those people working, and the denominator (bottom number) are those in the labor force. Total employment goes up -- and  unemployment goes down -- when EITHER the top number rises (more people working) -- OR the bottom number falls (less people in the labor force) -- or a combination of the two.

    A drop of more than 2 percent of the labor force -- 140 million people strong -- means that nearly 3 million former workers are neither  working nor looking for work. Their departure from the pool makes the unemployment measure go down. 

    During most recoveries, the participation rate typically rises as these "discouraged workers" return to work.


    While I find the group's research conclusions suspect, I would point interested readers towards the report, pages 67 forward. A rich collection of charts tell provide lots of fodder for more discussion on the subject . . .


    click for larger charts

    Participation rate rolling over


    Classic Economist Error: Projecting a cyclical trend -- to infinity


    Decreasing hours bely the "tight labor market" thesis

    Various Labor Pool Participation Rates, Demographics



    Fed Analysts Say Low Jobless Rate Doesn't Mask Labor Market Woes
    WSJ, March 31, 2006; Page A2

    Brookings Panel on Economic Activity
    March 30 and 31, 2006

    The Recent Decline in Labor Force Participation and its Implications for Potential Labor Supply
    Preliminary Draft (PDF)
    by Stephanie Aaronson, Bruce Fallick, Andrew Figura, Jonathan Pingle, and William Wascher
    Division of Research and Statistics, Board of Governors of the Federal Reserve System, March 2006
    (Download 200603bpea_aaronson.pdf)

    U.S. jobless rate misses "hidden" unemployed
    By Reuters  |  June 14, 2004

    Monday, April 03, 2006 | Permalink | Comments (44) | TrackBack (0)

    "The squalls never matter until they hit"

    As we await Alan Abelson's return from Timbuktu, the formidable Randall Forsyth continues to fill in, looking askance at the markets run up in the face of Oil and Interest Rates arisin'.

    He can turn a phrase:  "Yet those who have heeded the warning flags have lagged behind those who headed out with sails unfurled."

    For those who like your truthiness straight up, here is this week's Up & Down Wall Street:

    "MEANWHILE, THE TRANSITION OVER AT THE FEDERAL Reserve has been so seamless you'd hardly think there'd been a change at the top. At the first Federal Open Market Committee meeting chaired by Ben Bernanke, the panel chose to stick with much of the deathless prose of that Hemingway of the policy directive, Alan Greenspan. The FOMC did elaborate a bit on the outlook (about which Mr. G was uncharacteristically taciturn in the committee's policy announcements).

    While the committee notched the funds target up another quarter, to 4¾%, as everybody expected, it dashed the hopes of those who thought it might be done raising rates, or nearly so. Fed-funds futures are betting a 5% overnight rate is a virtual lock at the May 10 meeting. But the panel also said its decisions will depend on incoming data, so the market has placed a 40% probability on the FOMC going to 5¼% on June 29. A week earlier, however, the odds of a June hike were virtually nil.

    What's somewhat puzzling is the alacrity with which the stock market continues to soldier ahead in the face of rising interest rates. Indeed, for the first quarter, it turned in a performance worthy of an estimable 12 months. That especially was true of small stocks, with the Russell 2000 returning 13.9%, including reinvested dividends, according to Bloomberg's calculations. Nearly as good was gold, which soared 13% in the quarter, and the Philadelphia Gold and Silver stock index, which was up 10.6%. But gold's surge wasn't just a play on the weaker greenback, as the dollar index slipped only 1.6% in the quarter.

    Notwithstanding forecasts from the best and brightest, the big names continued to trail the little guys. Both the Dow Jones industrials and the Standard & Poor's 500 returned a none-too-shabby 4.2% for the quarter, including reinvested dividends, while the Nasdaq composite returned 6.4%. Bonds? The iShares Lehman Aggregate exchange- traded fund (ticker: AGG) lost about 0.77% for the quarter, including income. Yet, despite higher rates, real-estate mutual funds returned a sturdy 13.8% for the quarter, according to preliminary data from Lipper.

    What's striking is that, even as the big, boring stocks that dominate the major indexes lumber on, the speculative small fry continue to race ahead. Not just the real, respectable companies that make up the Russell 2000, but the ones found on the Bulletin Board and the Pink Sheets, where activity is cooking these days. The froth also can be seen in the ongoing rush into foreign mutual funds and the rising volume at online brokers.

    Somehow, aggressive trading while interest rates and oil prices are rising seems like a dangerous combination, like heading out for a sail when the white caps are whipping up and the sky is turning dark. Yet those who have heeded the warning flags have lagged behind those who headed out with sails unfurled. The problems have hit in places far removed, from Iceland to the Middle East bourses to New Zealand. The squalls never matter until they hit."  (emphasis added)

    Good stuff.


    Hey, Snow Problem
    Randall W. Forsyth
    Barron's April 3, 2006

    Saturday, April 01, 2006 | Permalink | Comments (15) | TrackBack (0)

    Real Fed Fund Rates

    Last week, we looked at the historical range of Federal Reserve Funds since 1946. 

    It was a simple mean reversion, and did not incorporate the post WWII price controls, the 1970s inflation spike, or the Bretton Woods agreement.

    As such, some implied that it overstated Fed Funds rate. Marketwatch's Rex Nutting had the suggestion that it would be instructive to look at real versus nominal Fed rates (see update 2).

    After the Fed meeting, Rex did just that, and analyzed the real (after inflation) Fed Funds Rate. His conclusions? 

    "Adjusted for the increase in the consumer price index, the real federal funds rate has averaged 1.75% since 1956. Currently, the real rate is about 1.10%, with a fed funds rate of 4.75% and a trailing inflation rate of 3.65%.

    To bring rates back to the 50-year average, the Fed would need to raise rates or lower inflation by a cumulative 0.65%."

    Ahhh, but that's a simple mathematical exercise (like ours) that does not consider all the variations in economic time periods -- including periods of "low inflation and modest growth, times of high inflation and no growth."

    Which raises the obvious question:  What has the Fed Funds Rate looked like in similar periods of high productivity and high growth? 

    "The Fed achieved a soft landing in the economy in 1995. From late 1994 through mid-1998, the Fed managed to keep the fed funds rate relatively steady between 5.25% and 6%. The economy prospered, growing at an average rate of 3.7%. Inflation averaged 2.5%.

    During that time, the real fed funds rate averaged 3.1%, two full percentage points higher than today.

    This analysis suggests that, in a period of high productivity and high growth, it may take a somewhat higher real funds rate to keep inflation low.

    If the Fed wants a 3.1% real funds rate, it might have to boost nominal rates another 2 percentage points to 6.75%. The Fed probably wouldn't have to do all eight quarter-point hikes, because that much tightening would probably have some impact on lowering the inflation rate (otherwise, why do it?).

    If inflation rates moderated to 2.5% or so under the pressure of Fed tightening, the Fed could probably stop at 5.50%

    That's my number (as well Lehman Brothers). To get there requires three more 1/4 point hikes.

    As to that soft landing, I would point out that the 1995 was a period in the middle of a secular Bull Market. Technology, networking and computers were the prime drivers, creating a virtuous cycle that powered the economy and markets higher. It was an organic business cycle expansion that kept going until it reached an upside blowoff in Spring 2000.

    That is quite different than the present stimulus driven economy. The Fed's tools are not being used to moderate this hot economy; Rather, they are slowly removing the economic stimulus namely, pulling interest rates up from 46 year lows.

    Those are the prime differences between 1995 and 2005:  a secular bull market driven by organic economic expansion, versus an economy that has been driven purely by a combination of government (war spending, tax cuts, deficit spending) and Monetary (rate cuts, increased money supply) stimulus.


    Monetary policy still far from normal
    Rex Nutting
    MarketWatch, 8:24 PM ET Mar 28, 2006

    Wednesday, March 29, 2006 | Permalink | Comments (13) | TrackBack (1)

    So much for "One and Done"

    So much for "One and Done."

    In raising rates the expected 1/4 point, the Fed announced that they are likely to keep increasing short term rates for the next few meetings.

    They threw a little bit of a head fake in there, noting "Economic growth has rebounded strongly in the current quarter but appears likely to moderate to a more sustainable pace."

    Trader's who left their feet on that were disappointed.

    By itself, that statement might have been a sign that the Fed was all but finished -- which would have been the fuel sending the Bulls racing to new heights.  A moderating economy on a glide path to a soft landing would not require additional monetary tightening.

    But as George Mason taught UConn, you have to play to the end of the game. In FOMC terms, that means reading to the end of the statement, where they shifted their focus to energy prices, noting the "potential to add to inflation pressures:"

    "As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures."

    Like the Huskies, the "One and Done" squad is now firmly eliminated from contention. Better luck next year.

    FOMC statement
    March 28, 2006

    Tuesday, March 28, 2006 | Permalink | Comments (19) | TrackBack (0)

    Famous Last Words

    Barron's notes that while Bernanke did not utter those four special words, the meaning of his speech this past Monday essentially said the same thing:

    IT'S DIFFERENT THIS TIME. No four words have been more costly to investors, whether they referred to tulips or dot-coms. And the greater the intellect behind each new theory, the more likely it will come a cropper. After all, it takes a certain genius to make a case for Dow 36,000.

    Ben Bernanke had his coming-out party last week, giving his first big speech as Fed chairman to the Economics Club of New York. And for that hip crowd, he chose an equally scintillating topic, the yield curve...

    The yield curve is the current hot topic, especially since the puppeteers at the Fed have been yanking up the short end for going on two years while the long end has drooped. The curve, as aficionados refer to it, is pretty much a straight line around 4.65% to 4.70%. The new Fed head offered several explanations of why that might be: Inflation's low and expected to stay that way, just as in the 'Fifties and 'Sixties; the level of "real," or inflation-adjusted, interest rates has moved down a notch, or there is a global glut of savings and not enough investment to mop it up.

    Bernanke also suggested what the yield curve didn't mean -- that the economy was about to slow, or worse, head into recession. No matter that every economic contraction has been presaged by a flat or inverted yield curve (that is, higher short-term than long-term rates, the inverse of the usual shape). This time is different, the former Princeton professor argued, and apparently persuaded much of the crowd.

    Not Northern Trust's Paul Kasriel, however. He points out that back in those Happy Days of low and stable interest rates, the August 1957-April 1958 and April 1960-February 1961 recessions both were preceded by flat but not inverted yield curves. Real short rates were even negative going into the '57 downturn, so the Fed wasn't exactly turning the screws real tight.

    A flat to inverted yield curve isn't so much a cause as a symptom of what's happening in the credit system. Investors are willing to lock up money for a decade or more without getting paid any extra only because they think short-term rates are going to fall in the future.

    Other symptoms? Housing rolling over, high Oil prices,  protectionist politicians, and my personal favorite, explanations for why its different this time . . .


    Famous Last Words
    Barron's MONDAY, MARCH 27, 2006

    Fact-Checking Bernanke’s Yield Curve Comments
    Paul L. Kasriel
    Northern Trust Global Economic Research, March 21, 2006

    Saturday, March 25, 2006 | Permalink | Comments (9) | TrackBack (0)

    New Real Estate Phase: Repricing Houses Downwards?

    As we noted Thursday, we had very strong existing home sales. But before you freak out about the Fed going to 6%, put this into context: After 5 months of decreasing sales, we had a nice bounce.

    Call it a counter-trend rally. While I have believed since August 2005 that Real Estate is cooling off, this most recent data point is likely the result of stragglers finally getting to close loose ends from the prior few months sales.

    Meanwhile, new home sales fell off the cliff, dropping 10.5% (seasonally adjusted) to an annual rate of 1.080 million. The WSJ reported the drop was "the biggest since an identical slide in April 1997 and the overall level of demand was the lowest since May 2003's 1.078 million annual rate." 

    Note, however, that any single month's New Home Sales Data tends to be unreliable; stick with a moving average.

    So where are we now in the Real Estate market? This certainly is not the start of a new super cycle. Inventory rose 5.2% near an all-time record, there is 5.3 months supply (3.03 million). The 10.6% year-over-year price gain to $209,000 is a median (as opposed to unit price weighted average) -- in other words, its skewed by the high end. The entry level has been priced out of the market for too many people, hence, the skewing of prices.

    I do suspect that much of the inventory out there is not for real -- i.e, sellers seeing if they can top tick the market and get top dollar, but not really entertaining many offers below their ask. These are casual, rather than serious sellers, and their inventory is merely tentative -- and temporary.

    Anecdotally, Real Estate  agents I have surveyed tell me the market is utterly dead -- and at the start of Spring, typically the beginning of the home shopping season (if you want to be in a new house for the kids to start the new school year in September).

    Underwater_1 And even more ominous for the macro economy, IBD reports that 29% of buyers in 2005 have zero equity in their house. The same is true for 9.4% of all mortgage borrowers. So while the sunshine crowd will tell you that homes are actually a savings vehicle, the reality for many home owners is quite different. (You are best off thinking about your house as a place to live that hopefully appreciates over the years -- not an ATM or a savings account).

    Also noteworthy: foreclosures are  on the rise.

    Thus, the RE market has dropped from white hot to red hot to mid-plateau. We are now entering a period where the actual sellers -- motivated, but not desperate -- may start repricing their houses downwards. This is a process that may take some time, but do not be surprised to see 10% decreases in housing prices by the Fall.

    This is unfolding pretty much on script.

    The impact will show up in sentiment and in consumer spending over the next 18 months or so. As noted back in Janaury, as the Real Estate Souffle falls, it will beget a slow motion slowdown.



    Mortgage rates down a bit, delinquencies up
    By Holden Lewis •, March 23, 2006

    New-Home Sales Tumble 10.5%;
    Durable-Goods Picture Is Mixed

    WSJ, March 25, 2006; Page A4

    Saturday, March 25, 2006 | Permalink | Comments (42) | TrackBack (0)

    Goodbye M3

    Today is the day M3 reaches its demise. We have discussed this repeatedly over the months.

    Thanks to the Prudent Investor, we are reminded that there is always a funny side to a sad story


    All we can do now is laugh . . .

    Thursday, March 23, 2006 | Permalink | Comments (7) | TrackBack (0)

    Exisiting Home Sales Pop

    Nar_20060323 Very strong existing home sales reported this morning -- the immediate reaction was for yields to tick up, and equities to head south. I assume the strength led traders to conclude the Fed has more work to do.

    I read the data as rather mixed. Inventory rose 5.2% in to a 5.3 months supply, of 3.03 million, near an all-time record (3.04 million in 1986). Median prices were up 10.6% year-over-year to $209,000.

    And that chart at right shows that this may just be a bounce off of low levels; Very often, sales get put off for a variety of reasons, and we may be seeing the prior 3 months unfinsished business getting put to bed -- hence, the bounce.

    As much as I mock the retailers for their weather dependent excuses, nice weather does bring out the home shoppers, and we have had a much warmer-than-usual winter -- especially January (those sales may not show up til February).

    Here's the specifics via the WSJ:

    The National Association of Realtors said that sales of existing single-family homes and condomiums rose by 5.2% in February to a seasonally adjusted annual rate of 6.91 million units. Singe-family home sales rose 4.7%, while sales of condominiums and co-ops jumped 8.8%.

    According to Freddie Mac, the national average commitment rate for a 30-year, conventional, fixed-rate mortgage was 6.25% in February, up from 6.15% in January; the rate was 5.63% in February 2005.

    The national median existing-home price was $209,000 in February, up 10.6 % from $189,000 a year ago. The median is a the price where half of the homes on the market sold for more and half sold for less.

    I think the working assumption in the pits and on the floor may be "so much for One and Done."

    Existing-Home Sales Rose By 5.2% in Latest Month
    WALL STREET JOURNAL, March 23, 2006 10:17 a.m.

    Thursday, March 23, 2006 | Permalink | Comments (16) | TrackBack (0)

    Does the CPI Reflect Reality?

    I almost missed this earlier this week, and its on point to our prior discussion: The WSJ asked its readers: "Does the government's consumer-price index accurately reflect the inflation rate you face?"

    Not surprisingly, 75% said CPI understates inflation:





    WSJ Poll
    Mar-20 5:30 pm

    Wednesday, March 22, 2006 | Permalink | Comments (20) | TrackBack (0)

    Historical Fed Fund Ranges

    As I have stated repeatedly, I do not buy this "One and Done" meme. This is the 3rd attempt at it -- the first being last June, when Dallas Fed Chair Fisher issued his now infamous 8th inning comments. Then in January, the moonshot was once again launched on that idea.

    The most recent rally started last week ont he Medley advisors claim that it was One and Done (although that was subsequently revised to "maybe 1 or 2").

    I find all these Fed Kremlinologists at to be junk analysis at best. My preference is for data and quantitative analysis.

    With that in mind, I went to the St. Louis Fed site and downloaded all their Federal Funds Rate data. Here's a graphic depiction of what the median monthly historical rates look like:




    This chart suggest that in order for Fed Funds to revert to the mean, the Federal Reserve Board has a ways to go -- both in rates and in time.

    Note that we are now at 4.5%. Even if the Fed were to stand pat at 4.5%, the passage of time will move the 2000 - 2006 monthly median closer to the prior market periods median -- each passing month raises the median.


    UPDATE: March 21, 2006 5:07pm

    CB raises the question -- correctly -- that equating average funds rate is not sound given the difference in inflation; Low now, 10% then.

    My response is that I believe inflation is much higher than the present CPI reflects; The key change in CPI construction was the owners equivalent rent, which we addressed repeatedly here. Without the 1983 owners equivalent rent adjustment, the CPI would be more like 5.3% -- not the 10+% of the 1970s, but certainly not the 1-2% its claimed to be at present.

    Given the significance of housing to this economy -- and with Housing Affordability Index at 14 year lows -- its kinda silly to take CPI data seriously as a true measure of inflation.

    UPDATE 2: March 22, 2006 6:07am

    Rex Nutting makes an even better suggestion:  Apply the same analysis using real versus nominal Fed rates.

    I'm not a huge fan of Boskin, PCE, or even the CPI for that matter -- I do not think they reflect inflation reality as experienced int he real world. But controlling for Real Fed Fund Rates (as opposed to nominal) may be more revealing than not controlling for inflation

    The St.L Fed is such a pleasure to work with -- they give you all the data formatted in Excel already! Its intriguing -- let me see if I can find the Real Fed data in Excel (or pull it off of Bloomberg).

    Wednesday, March 22, 2006 | Permalink | Comments (12) | TrackBack (1)

    Federal Reserve Speech Roundup

    Lots of jawboning out of the Fed these days.

    Instead of joining the list of pundits giving you their spin. Instead of joining that parade, I'd rather send you to the horses collective mouths.

    These are the 3 most important Fed speeches and commentaries of the past month:

    •   Reflections on the Yield Curve and Monetary Policy
    Remarks by Chairman Ben S. Bernanke Before the Economic Club of New York, NY, March 20, 2006
    (This one was well publicized and will be taken apart)

    •  Comments to New England Realtors Conference
    Cathy E. Minehan, President and Chief Executive Officer, Federal Reserve Bank of Boston, March 20, 2006
    (Non-voting member tells New England Realtors Conference she is concerned about the impact on the economy of declining construction and a drop in household wealth)

    •  Remarks at the Japan Society Corporate Luncheon in New York City
    Timothy F. Geithner, President and Chief Executive Officer, NY Federal Reserve, March 9, 2006
    (Permanent voting member, warns of the "the risk that monetary policy would be too accommodative")


    The last 2 in particular fits my thesis:  A Real Estate driven economy that has robust inflationary pressures everywhere -- except in wages . . . 

    Tuesday, March 21, 2006 | Permalink | Comments (5) | TrackBack (1)

    February CPI Tame

    Cpi_20060316090605 I would be remiss if I failed to address yesterday's CPI data, which can be described as tepid. And as you may have surmised, this does not change my views about inflation. One data point does not make a trend.

    As the chart at left shows, the slight downtick in inflation is hardly trendbusting.

    Indeed, the prime source of moderation in February was declining energy prices. Funny, the inflation ex-energy crowd -- after 52 months of rising oil prices -- decided that NOW was the time to report CPI with energy. Cute.

    Even more significantly, the offsetting items that dropped in price are the typically volatile issues that may (or may not) rise next month. Indeed, from the lows in February of ~$59.25, Oil has rallied to $65.

    Of course, when the March CPI comes out next month, we will hear that "its only a short term energy spike."  I predict in the March CPI, the emphasis will  return to CPI ex-energy. That's consistent with the 4 year history of CPI inflation ex-inflation.

    On to the details. The BLS reported Energy prices fell 1.2% -- after a 5% rise in January (Gee, why don't we report those 2 data points together like they did in response to tepid Retail Sales?). The WSJ notes "energy prices "were still 20% higher than a year ago. Gasoline prices fell by 1%, and natural-gas costs dropped 4.5%, the sharpest slide since September 2001."

    I am nothing if not consistent:  I think you have to consider the decrease in energy this month (as opposed to those who have ignored it for 4 years). But we have already seen much of those price drops reversed in March. I am already gearing up to respond to CPI next month when the Booyah crowd selectively claims: "its only a volatile energy number."

    Note that in annual terms, overall CPI rose 3.6% -- and thats with all of the absurdities that number embodies.

    This has led -- for the 3rd time in 8 months, mind you -- for the Fed to be Two and Through or even One and Done. Marketwatch's Rex Nutting observed:

    "Futures markets now expect the federal funds rate to peak at 5% in May, rather than at 5.25% in June as expected just four days ago. There's even a small chance -- about 1-in-6 -- that the Fed will call it quits after one more rate hike, leaving the fed funds rate at 4.75%. See interactive graphic tracking federal funds rate.

    The rally in the federal funds futures market at the Chicago Board of Trade mirrors a big rally in the bond market Thursday. The yield on the 10-year benchmark note fell to 4.65% from 4.73% Wednesday. The 10-year was trading significantly below the 4.75% rate expected for the federal funds rate just two weeks hence."

    Rex also points out:

    The core inflation rate remained at 2.1% year-over-year as the consumer price index rose a moderate 0.1% in February.

    Import prices excluding fuels have risen just 0.8% in the past year.

    Real weekly wages are down 0.1% in the past year.

    Housing starts fell 8% in February. Mortgage applications are down 20% year-over-year.

    Weekly jobless claims rose to the highest level of the year.

    Retail sales fell 1.3% in February.

    Manufacturing activity in the Philadelphia region showed a slower pace of growth in March, and a steady reduction in inflation pressures.

    If the March CPI data (to be released April 20) is even modestly robust, we can all enjoy a chuckle when the One and Done crowd's heads explode . . .

    Energy Prices Cool Off, Helping Restrain CPI
    WALL STREET JOURNAL, March 16, 2006 5:31 p.m.

    Fed likely to stop at 5%, market says
    Rex Nutting,
    MarketWatch, 3:01 PM ET Mar 16, 2006

    Consumer prices tame in February
    Core CPI rate rises 0.1%, keeping yearly gain to 2.1%
    Rex Nutting
    MarketWatch, 10:02 AM ET Mar 16, 2006

    Friday, March 17, 2006 | Permalink | Comments (5) | TrackBack (0)

    NFP Day

    Today's NFP data has the potential of being extremely significant to the market -- more so than usual. Why? Blame Interest rates and Japan.

    For the longest time, investors have managed to avoid the obvious -- that inflation has been fairly robust -- and not just in energy prices.

    The scales have begun falling from Investor's eyes, as the not-very-efficient market place of ideas has begun coming to grips with reality. That means rates are going higher, with all the appurtenant repurcussions thereto. The recent selloff in the 10 year Bond saw rates spike to 4.73%; the Fed will take their target rates to 4.75% later this month, and then a likely 5% at the following meeting.

    Wall Street is hoping that's the last of it. And we know what happens when The Street starts relying on Hope for its Salvation.

    That Hope may be misplaced, as its no longer just the US Fed's game: The Central Bank in Japan has moved away from its "super easy" stance, raising rates for the first time since Disco was in vogue. European Central Bankers are likely to follow.

    Nfp_236 Which brings us to today's Non-Farm Payroll report. The Consensus from Dow Jones is 220,000 (Bloomberg is 210k). The range is 105,000 to 300,000, with expectations that unemployment ticks up to 4.8% or so, and a month-over-month Average Hourly Earnings increase of 0.3%. 

    Today's NFP report is one of those lauded "data points" that the Fed has said it will be watching closely. A number that's too strong -- and we haven't see a real strong upside surprise in a long time -- would start tongues awagging that 5.5% will be the new Fed target. Even the Average Hourly Earnings increase could spook them, despite the real possibility that the bulk of the gains are in construction, particularly NOLA.   

    A number that's weak would confirm the fears that the economy is slowing and the Fed has already done its damage. That would (perversely) lead folks to the conclusion that perhaps the Fed is done, and a rally could be in the offing. That's the short term reaction; longer term, slowing economy and weaking earnings are hardly a tonic for equities.    

    With the market now down 5 consecutive days -- 6 for Nasdaq -- an oversold rally remains a possibility. But don't go by me for very short term trading -- I incorrectly thought a week ago that we could see a pop.

    But beyond the equity market's initial twitch, the key to today is to watch the Bond market. That will provide insight into expectations for how fast and furious the Fed will drive rates higher.


    Forecast:   I gotta stick with the Under (which again perversely helps the Bullish case) if only because its worked so well for so long. The Over (perversely X 3) plays into the longer term Fed overtightening Bear thesis, and shifts the focus to the bond ghouls sudden rediscovery of the forces of inflation . . .

    Friday, March 10, 2006 | Permalink | Comments (3) | TrackBack (0)

    Thomas’s Ham & Eggery Guide to Inflation

    Last week saw a hefty spike in interest rates. In particular, the 10 Year Bond got slammed, as rates climbed to 4.684%, levels not seen since June 2004.

    As we have discussed previously, we believe that ongoing inflation will be the key to the Fed, housing, the consumer, and therefore how equity markets will perform. The great irony of this is that most Wall Street economists do not see the inflation we do. Their focus has been on the core rate (ex food and energy). They also ignore the oddities of how CPI is computed, which tends to dramatically understate actual price increases.

    Indeed, Economists may be the last people you should ask about real inflation. Sure, if you have a question about the Boskin PCE deflator, well then sure, any old dismal scientist will be your go-to-guy. But if you want the straight dope on inflation as it exists in the real world, you are much better off asking a housewife or a business owner.

    So that’s exactly what we did:

    Over the weekend, we spoke to numerous business owners. What they told us is very consistent with an economy that has reflated, and whose prices across a broad spectrum of areas have increased.

    The broadest overview came from Thomas’s Ham & Eggery, a well konw Long Island breakfast joint (Carle Place ) that has been in business at the same place for over 33 years. If you go there on weekends, you better get there early, ‘cause by 8:30 there is a line out the door.

    The menu prices had risen modestly since my last visit, so I spoke with Tom. He usually changes up the menu every now and again, but informed me that “this was the first purely price based menu change” he’s ever done. We discussed the factors driving the increase, and its exactly the sort of broad based inflation you would imagine:

    -Electricity costs significantly more than 12 months ago;
    -Food prices have risen (although not sharply);
    -Sugar is noticeably higher;
    -Energy Surcharges are showing up on all deliveries;
    -Paper goods are up significantly;
    -Insurance costs are rising 11-15% per year;
    -Material products are also higher;
        (aluminum foil, styrofoam, wax paper etc.)
    - Rent increase on the next lease renewal is a concern;
    -Wages have remained stable throughout.

    All the concerns we heard at Thomas’s were repeated by other merchants and entrepreneurs. And while we are well aware of the dangers of anecdotal evidence, we are just as concerned with the opposite: an over reliance on economic modeling which claims there is little or no inflation, despite a plethora of evidence to the contrary.

    Our advice to the Dismal Set:  Economists need to get out from under the fluorescent glow, and experience real world firsthand. If they did, they would experience price increases and understand why we expect more Rate Increases, even beyond the upcoming FOMC meeting.

    Tuesday, March 07, 2006 | Permalink | Comments (20) | TrackBack (0)

    Can M3 be Saved?

    I always find it curious when a good source of public data gets cancelled by an administrative source.

    Mass layoffs were the first victim, killed by the White House in 2003.

    Next came the proposed ending of funding for a Census Bureau survey on the economic well-being of U.S. residents -- a move decried by both the left and the right.

    But the most egregious and unwarranted cancellation of a data source has been the Federal Reserve plan to end M3 reporting. It struck me that Ben Bernanke's defense of this was the first blot on his tenure as new Fed Chair.

    Its a clean historical data series. Its accurate, not seasonally adjusted, not hedonically altered. There is really no good reason to cancel this.

    For a nation that is capable of scrapping together 100s of millions of dollars for an Alaskan bridge to nowhere, it is ridiculous that an important measure of money supply will no longer be reported, ostensibly as a cost cutting measure.

    Puh-leeze. That's tough to believe, especially when we look at M3.   

    M2_v_m3 Its no coincidence that M3 has been soaring in advance of its impending death: Jim Picerno observes that "The broadest measure of U.S. money supply -- the so-called M3 -- has less than a month to live, but its swan song continues to be one of growth, and growth that's notably higher relative to that of M2, the official replacement for the doomed series."

    As the Federal Reserve data makes clear, M3 is growing at a much faster pace than M2 -- which  has a time-lag and contains no "electronic" money.

    Given the current account deficit, and any structural risks to the US dollar, as a fund manager, I want access to more and not less information. 

    Its not too late to save M3: Congressman Ron Paul is sponsoring a bill that will require the Fed to continue to monitor and report M3. This bill will need your support.

    You can contact the congressman at:

    Ron Paul
    Washington, DC
    203 Cannon House Office Building
    Washington, DC 20515
    Phone Number: (202) 225-2831

    A historically clean, accurate data source is a terrible thing to waste . . .



    Related links:

    US FED discontinues reporting M3 data

    The End of M3 Reporting?


    Where Do All Those Numbers Come From?

    Money Supply and the End of M3

    Historical M2 vs M3

    Chart of the Week: M1, M2, M3 Money Supply Components



    M3 Reporting: Whats The Big Deal?

    Monday, March 06, 2006 | Permalink | Comments (25) | TrackBack (0)

    Radio Economics: The Greenspan Era

    I recently did another Radio Economics interview with James Reese.

    We covered alot of the Alan Greenspan era, including

    -the Greenspan model;
    -the Alan Greenspan myths
    -Ben Benanke
    -the future of the macro economy.

    Surprisingly, the rating via Apple is: Squeaky Clean (G) / 18.9MB / 62Kbps / 41min 19sec )

    You can get it at:

    Apple iTunes

    Yahoo Podcasts




    Man, is that nasal voice painful or what?

    Sunday, March 05, 2006 | Permalink | Comments (1) | TrackBack (0)

    Fundamentally Speaking . . .

    On Wednesday morn, Doug Kass opined:

    Fundamentally Speaking

    The fundamental problems with the market run deep.

  • We live in a world in which the consumer is spent-up, not pent-up. If you don't believe me, the Federal Reserve expanded on this subject last week. It is inevitable that the American consumer will cease its consumption binge of the last decade and begin to retrench and save as the one-time benefit of refinancing cash-outs slows to a trickle.
  • A parabolic boom in housing prices in certain "hot" regions of the U.S. -- and abroad -- has stretched the relationship between household incomes to housing prices to levels never, ever seen in the last century.
  • Spring 2006 will mark a substantive resetting of rates on adjustable-rate and teaser mortgage loans, pressing the consumer ever more.
  • Our economy's foundation is based on an asset-appreciation dependency, compared to past cycles which relied on income and wage growth.
  • I continue to reject the government's notion that inflation is in retreat. Inflation statistics delivered by the BLS are works of fiction, as stubbornly high energy prices, tuition, food, housing, commodities, insurance and other costs are serving to pressure the consumers' real disposable incomes.
  • The 28-year high in corporate profit margins is unsustainable and likely to revert closer to the mean as (1) the benefits of four years of cost cutting subside, and (2) cost pressures overcome pricing power.
  • A more hawkish Federal Reserve will raise federal funds to higher levels than the consensus expected.
  • (Notwithstanding the results from various investor surveys) the body of investors to be overly complacent (with a high measure of bullish conceit) as fear and doubt had been driven from Wall Street.
  • >

    A Second Shot Across the Bow?
    Doug Kass
    Street Insight,3/1/2006 8:39 AM EST

    Friday, March 03, 2006 | Permalink | Comments (11) | TrackBack (0)


    The redesigned $10 quietly slipped into circulation yesterday:


    The Bureau of Engraving and Printing explains:

    "The new $10 note, which is the third denomination to be redesigned in the series, includes subtle shades of orange, yellow and red along with images of the Statue of Liberty's torch and the words "We the People" from the United States Constitution. The new $10 note was introduced on March 2, 2006."

    There are a slew of Security and Design Features, if that sort of stuff interests you . . .


    The New Currency
    Department of the Treasury
    Bureau of Engraving and Printing

    'We the People' getting around on new colorized $10 bill   
    Martin Crutsinger
    ASSOCIATED PRESS, 12:48 p.m. March 2, 2006

    Friday, March 03, 2006 | Permalink | Comments (7) | TrackBack (0)

    The "Merely rich" versus the "Super-rich"

    Wsj_capit_20060301192109 Interesting article by David Wessel in the free section of the WSJ today: Rich Get Richer, But Not as Fast As You Think.

    Its a follow up to the Federal Reserve's recent triannual  study we discussed last week,  Stagnant Net Worth for Typical US Family.   

    When looking at who has what share of America's Net Worth, a few data points leap out: The Richest 10% owns 69.5% of the assets, up from 67.4% in 1989.

    Note that the Fed survey explicitly excludes folks on the Forbes 400 list of the very wealthiest Americans. I believe the Fed eventually breaks down the latest numbers on the richest one million families, the top 1%. That group of Super Rich 1% holds about one-third of the total wealth in the nation; The next 9% also holds about a third.

    The group below the top 10% --the 75% - 89.9%  slice -- owns 17.6% -- slightly more than their population percentage might suggest numerically. This group contains the heart of the middle class (and upper middle class), and as we have seen, they have been shrinking.

    Wessel writes:

    "The Federal Reserve does a lot of things. It sets interest rates. It issues dollar bills. It regulates banks. And once every three years it tells us how well America's rich are doing and if they're getting richer.

    The word from the Fed's new Survey of Consumer Finances: The rich are doing extremely well. But their slice of the pie doesn't seem to be growing as fast as one might expect in light of the persistent widening of the gap between annual incomes of rich and poor.

    American families had net worth -- the value of houses, cars, 401(k) plans, stock portfolios and saving accounts minus mortgages and other debts -- of $50 trillion in 2004, according to the Fed. Its estimate is based on surveys of 4,522 families, with special efforts to include the rich.

    As New York University economist Edward Wolff observes, the Fed doesn't count defined-benefit pension plans, money that, in a sense, belongs to the workers to whom pensions have been promised. Recent atrophying of these pension promises hurts the middle and upper-middle class more than the very top; ignoring that may understate the increasing concentration of wealth at the top."

    Interesting stuff, to say the least.

    Here's the breakdown of wealth (net worth, not income), by quartile, over the past 4 surveys:

    Share of the Wealth

    Percentile Wealth in Millions of Dollars Share of Wealth in Percentage Terms
    Bottom 25% n/a 0
    24 to 49.9% 1,319,977.5 2.6
    50 to 74.9% 5,195,835 10.3
    75 to 89.9% 8,856,460.5 17.6
    90 to 100% 34,910,182 69.5
    Bottom 25% n/a 0
    25-49.9% 1,251,375 2.8
    50-74.9% 4,701,975 10.5
    75-89.9% 7,645,635 17
    90-100% 31,269,465 69.7
    Bottom 25% n/a 0
    25-49.9% 1,067,040 3.2
    50-74.9% 3,824,415 11.4
    75-89.9% 5,734,314 17.1
    90-100% 23,025,492 68.5
    Bottom 25% n/a 0
    25-49.9% 930,600 3.6
    50-74.9% 3,034,350 11.8
    75-89.9% 4,359,960 16.9
    90-100% 17,490,330 67.8

    Courtesty of WSJ, Federal Reserve's Survey of Consumer Finances


    Rich Get Richer, But Not as Fast As You Think
    Capital column by David Wessel
    WSJ, March 2, 2006; Page A2   (no sub required)

    Thursday, March 02, 2006 | Permalink | Comments (19) | TrackBack (0)

    Fed: Stagnant Net Worth for Typical US Family

    Every 3 years, the Federal Reserve undertakes a massive survey of nearly 5,000 US families. The interview process is comprehensive, covering all manners of financial information -- and its intensive, taking between 80 minutes and 2 hours.

    Its the Federal Reserve's Report on U.S. Family Finances, and it quantifies what most people already know: The average family is not making much economic progress:      

    "After growing rapidly during the boom of the 1990s, the net worth of the typical American family rose only 1.5% after inflation between 2001 and 2004, the Federal Reserve said in an update of a survey it does once every three years.

    The Fed said the net worth of the median American family -- the one smack in the statistical middle -- was $93,100 in 2004. Net worth, the difference between a family's assets and liabilities, rose a robust 10.3% between 1998 and 2001 and 17.4% in the three-year interval before that.

    A booming housing market boosted the typical American family's wealth between 2001 and 2004, but stagnant stock prices and rising debt offset many of those gains."

    The Fed helps explain what many politicans have been unable to grasp: the disconnect between rosy economic headline data and real life experiences for most families.

    The report also gives lie to much of the foolish spin we have heard from some politicians and from the economic charlatans -- those people who know better (or at least should know better), but knowingly deceive the public in pursuit of their own political or economic agenda.

    A few items pop out from the report:

    •  Rising debt has offset the boom in housing;
    •  Inflation continues to eat into family cash flow;
    •  Income remains stagnant;
    •  Savings has slipped to zero; 

    click for larger graphic


    courtesy of WSJ

    And, its no surprise that the gap between economic strata has widened. This is part of the ongoing squeeze on the middle class:

    "The report, the most comprehensive survey of household wealth, also found a widening of the gap between households at the top and the bottom of the economic ladder. "While the typical American household basically ran in place, less affluent households actually lost ground," said Stephen Brobeck, executive director of the Consumer Federation of America.

    The net worth of the typical family in the richest 10% rose to $831,600, a 6.5% increase from 2001, adjusted for inflation. In contrast, the net worth of the typical family in the bottom 25% fell 1.5% to $13,300.

    Meanwhile, the typical family took on more debt. After declining for years, mortgage and other debt as a percentage of total family assets rose to 15% in 2004 from 12.1%, the Fed said. "The largest part of that increase was attributable to debt secured by real estate," the report said. "As debt rose over the period, families devoted more of their incomes to servicing their debts, despite a general decline in interest rates."

    All of the above has been very visible in the economic data, if you ignore the headlines and dig into thge underlying data: Job creation, income, inflation, debt, savings rate, foreclosure and bankruptcy. 

    Which ever political group figures this is the primary basis for the disconnect between the so called official data and the self reported economic concerns -- and responds to it -- stands to do well in the next election . . .   


    Typical U.S. Family's Net Worth Edged Up Only 1.5% in '01-'04
    WSJ, February 24, 2006; Page A4

    Recent Changes in U.S. Family Finances:
    Evidence from the 2001 and 2004 Survey of Consumer Finances

    Brian K. Bucks, Arthur B. Kennickell, and Kevin B. Moore
    Federal Reserve Board, Division of Research and Statistics
    February 2006

    Friday, February 24, 2006 | Permalink | Comments (25) | TrackBack (4)

    Is the Fed Done? Depends on What Page You're Reading

    Fed_wsjcom_20060221174143Inflation remains a worry for some Fed officials, and might require further rate hikes.

    Or, the Fed is nearly done with their tightening cycle.

    Those are the themes in a pair of separate WSJ articles today. It should come as no surprise then, that the investor reaction to the Fed minutes might have been somewhat confused.

    Greg Ip, the Journal's Fed watcher, wrote:

    "Although officials suggested that rates are "close to where [they] needed to be," some increases "might be needed" to contain the risk of higher inflation. Some officials went further, arguing that the case for higher rates was reinforced by current "readings on core inflation and inflation expectations that were somewhat higher than was desirable over the long run."  (emphasis added)

    Inflation has fluctuated between 1.9% and 2.3% for the past year and a half, based on the Fed's preferred price index."

    The other side of the case was presented by Credit Markets reporter Michael Derby, who noted:

    "The release of a Federal Reserve document that suggested to some bond investors that rate increases are nearing their end failed to have much impact on U.S. Treasury prices yesterday and left the market in the same modestly negative spot it was in ahead of the release.

    According to the minutes from the Jan. 31 Federal Open Market Committee meeting, Fed officials, while worried about upside risks to inflation, said that "the stance of policy seemed close to where it needed to be given the current outlook." But they added, in a familiar refrain, that "some further policy firming might be needed to keep inflation pressures contained and the risks to price stability and sustainable."

    The FOMC minutes for most in the market confirmed what they already knew: the Fed has a modest amount of rate increases left in it, and how that tightening plays out will be the product of what the economic data do. As such, the lack of surprise stripped from the market any catalyst to trade dramatically. In turn, that left the market very close to the same negative tone that dominated the day."  (emphasis added)


    So is the Fed almost done, or do they have more work to do?  The answer depends upon what page you are reading . . .


    Fed Minutes Indicate Inflation Still a Worry for Some Officials
    WSJ, February 22, 2006; Page A2

    Investors React Coolly To Signals by FOMC
    Treasurys Decline Slightly As Fed Indicates Increases In Rates Could End Soon
    WSJ, February 22, 2006; Page C7

    Wednesday, February 22, 2006 | Permalink | Comments (1) | TrackBack (0)

    Continuing Upside Risks to Inflation

    Here's the key inflation paragraph from yesterday's Fed minutes

    "Participants noted that, while the pass-through of higher energy and other commodity prices to prices of core goods and services had remained subdued, there were continuing upside risks to inflation from these sources. Whatever the size of such pass-through effects, however, it was thought that they would probably be temporary in nature and likely diminish as energy prices flattened out, as long as inflation expectations did not move higher. In that regard, participants were encouraged that, despite recent energy price increases, survey measures of inflation expectations had notched down and longer-term inflation compensation in financial markets was little changed. Although high profit margins could imply some existing pricing power, they might also provide a cushion to absorb some future cost increases. Indeed, anecdotal reports suggested that the ability of firms to pass through higher input costs generally remained limited. Nevertheless, the increased prices of energy and other commodities and the possibility of a further rise in resource utilization, which some members viewed as nearly full at present, represented continuing risks, potentially adding to inflation pressures."
    (emphasis added)

    By now, you should know my views on the subject . . .


    Minutes of the Federal Open Market Committee
    FRB, January 31, 2006

    Wednesday, February 22, 2006 | Permalink | Comments (1) | TrackBack (0)

    Further Yield Curve Inversion "a Given"

    Or so says the Treasurys team at Jefferies & Co. in New York.

    I cannot say I disagree. The 10-year Treasury is looking to trade between 4.48% and 4.62% this week.

    Further, with at least one and likely two and possibly three and an outside chance of four more Fed Reserve tightenings, the curve is likely to invert further:

    "Market participants are having an easier time swallowing the idea that short-term rates are likely to remain higher for a while than longer-term ones. Some participants have said they expect this aberration, known as a yield-curve inversion, to last for the rest of the year.

    Late Friday, the two-year Treasury was yielding about 0.12 percentage point more than the 10-year Treasury and 0.15 percentage point more than the 30-year Treasury.

    The Treasurys team at Jefferies & Co. in New York said further inversion of the yield curve is basically a given.

    That is because government sales of $22 billion of two-year Treasurys tomorrow and $14 billion of five-year Treasurys Thursday will likely add pressure to those maturities and send their yields higher. Month-end buying by longer-term investors who need to match their portfolios to extensions in benchmark indexes will likely support 10- and 30-year maturities and send those yields lower."


    Treasurys May Remain Steady As Yield-Curve Inversion Persists
    WSJ, February 20, 2006; Page C10

    Tuesday, February 21, 2006 | Permalink | Comments (4) | TrackBack (0)

    A Curious Dependency on Data

    Bol_logo I was planning on linking to Paul Kasriel’s Critique of Bernanke's Congressional testimony anyway -- and then I saw that this morning's Barron's excerpted the most relevant parts of it.

    Pick your poison: the short version is here, the full 7 pager is linked at bottom:

    "BERNANKE, WHILE DIFFERING IN STYLE, remains consonant with the substance of Fed policy, implying further increases in its federal-funds target are likely. Another quarter-point hike, to 4¾%, is all but certain at the next FOMC meeting March 28. And the fed-funds futures market is putting even money on a 5% funds rate being approved at the May 10 confab. The risks to the economy, according to Bennie and the Feds, is that the economy could overheat and bring further upward pressure on inflation without further monetary tightening. Those decisions will be dependent on incoming economic data.

    This "data-dependent" policy approach strikes Paul Kasriel, Northern Trust's director of economic research, as curious, given that monetary policy affects the economy with a lag of as much as 18 months. Bernanke last week also dismissed the notion that the negative yield curve -- when short-term rates are higher than long-term ones, the opposite of the usual configuration -- is a precursor of an economic downturn. Kasriel points to a similar situation in the second quarter of 2000, when the economy boomed at a 6.4% annual rate -- just before contracting in the following quarter. The curve then also was negative, and also dismissed as a portent.

    Another leading indicator (which also has fallen into disrepute with the consensus) is the real money supply, M2, adjusted for inflation. Put simply, money is hardly growing much faster than prices, leaving little to fund real activity. Indeed, Kasriel points out, money growth is weaker than it was near the onset of the 2001 recession.

    Clearly, the yield curve and the money supply can, and have, been explained away by the best and the brightest in the economics field. Yet there is another symptom consistent with the same diagnosis: Commodity prices are off fairly sharply since the beginning of February -- not just oil, but gold, as well. But all these forward-looking market indicators are ignored.

    "For all the talk about a more-transparent Bernanke Fed, we still don't have a clue as to what leading indicators the Fed uses to guide its policy decisions other than the latest set of economic reports," Kasriel laments. "The more things change, the more they stay the same."

    Amen to that brother . . .


    Chairman Bernanke’s Debut – Kasriel’s Critique (pdf)
    Paul Kasriel
    Northern Trust, February 15, 2006

    Meet the New Boss
    Barrin's MONDAY, FEBRUARY 20, 2006

    Saturday, February 18, 2006 | Permalink | Comments (3) | TrackBack (0)

    Secular Changes in Interest Rates

    I really like the way this chart, by Joseph Ellis, presents this information:

    Long-term interest-rate changes and the stock market

    click for larger graph


    Source:  Ahead of the Curve


    Ellis observes:

    Because of the inverse relationship between interest rates and stocks’ price-earnings ratios, rising interest rates from 1960 to 1982 contributed to a compound annual appreciation of only 2.9% in the S&P 500 Index.

    Conversely, falling interest rates from 1982 to 2003 were a major long-term stimulus to the stock market, helping produce compound annual growth in the S&P 500 of 10.5%. Note that bear markets from 1960 to 1982 were more frequent and longer, whereas from 1982 to 2003 they were less frequent and shorter in duration.

    Thursday, February 16, 2006 | Permalink | Comments (19) | TrackBack (0)

    Economists React to Bernanke Testimony



    Our earlier comments were picked up by the WSJ. Its in the public (free) section, and has lots of other comments by lots of other commetators. It is definitely worth a look.

    Here's my blather :

    No surprises today: He struck a hawkish tone, as expected. This is consistent with what we heard from his warm-up acts last week. Chicago Fed Prez Michael Moskow and Dallas Fed Prez Richard "8th Inning" Fisher struck similar notes. Moskow suggested that rates are "historically low," that inflation was "creeping into the core" CPI rate, and suggested that rates may need to "rise further beyond neutral" to kill inflation. We listened hard as we could to the new Fed head, but were unable to discern anything inconsistent with Moskow's speech. Bernanke stated that "resource utilization was rising, cost pressures increasing, and short-term interest rates still relatively low." That hardly implies a Fed nearly finished with their tightening cycle. -- Barry Ritholtz, Ritholtz Research; blog: The Big Picture


    Economists React to Bernanke Testimony
    'Greenspan Clone'? Inflation Hawk? And What About Housing and Jobs?

    February 15, 2006 3:49 p.m.

    Wednesday, February 15, 2006 | Permalink | Comments (6) | TrackBack (0)

    Bernanke Speaks

    Fed Chair Ben S. Bernanke,  in his prepared comments, observes:

    "With the economy expanding at a solid pace, resource utilization rising, cost pressures increasing, and short-term interest rates still relatively low, the Federal Open Market Committee (FOMC) over the course of 2005 continued the process of removing monetary policy accommodation, raising the federal funds rate 2 percentage points in eight increments of 25 basis points each. At its meeting on January 31 of this year, the FOMC raised the federal funds rate another 1/4 percentage point, bringing its level to 4-1/2 percent."

    On another note, how goddamned annoying is that CNBC sound effect? Jesus Christ, what are you people 4 years old? Its the Fed Chair, not a f*%$# video game.

    I guess that means I am hungry and cranky. Time for a lunch break soon . . .


    UPDATE:  February 15, 2005 4:05pm

    I was just looking over some of the Fed Chief's testimony. The Capital Surplus discussion made me giggle. Everytime I hear the "Savings Glut" phrase, I cannot help but be reminded of Mr. Montgomery C. Burns (of Simpsons fame):

    "Oh, meltdown. it's one of those annoying "buzzwords." We prefer to call it an unrequested fission surplus."



    Testimony of Chairman Ben S. Bernanke
    Semiannual Monetary Policy Report to the Congress
    Before the Committee on Financial Services, U.S. House of Representatives
    February 15, 2006

    Wednesday, February 15, 2006 | Permalink | Comments (25) | TrackBack (1)

    The Longest 8th Inning in the History of Baseball

    Back on June 1, 2005, Dallas Fed President Richard Fisher told CNBC:

    “We are clearly in an 8th inning of a tightening cycle, and we have the ninth inning coming up at the end of June.”

    The markets, which had already bounced off of their May lows, gathered themselves together over the next few days, and then made a new leg up. Many people credited that move to Fisher. It only was halted by the late August hurricanes in the Gulf, and the destruction of New Orleans. During the first week of this year, we again had “lift off,” similarly premised on the idea that the Fed tightening cycle was just about over.

    This leads me to a question:

    How much of the rallies during the past 12 months have been based, at least in part, upon the false premise that the Fed is nearly through tightening?

    Long time readers of mine know that I believe markets rarely move in a this happened, so markets did that basis. The complex choreography of capital markets are far more intricate than many folks realize, hardly as efficient as most academics believe, and may be far more attuned to the rules of chaos than those of pure randomness.

    Is the Fed “just about done?”  Given the recent jawboning from various Fed officials, I believe that is a premature declaration. Last week, Chicago Federal Reserve Bank President Moskow suggested that rates are “historically low,” that inflation was “creeping into the core” CPI rate. Further, he spooked the markets when he suggested that rates may need to “rise further beyond neutral” to kill inflation.

    The consensus is evolving amongst various Fed officials that erring on the side of over-tightening is much preferred to letting inflation accelerate. New Fed head Bernanke may even “brush aside lawmakers' calls for a pause” and “vow vigilance against inflation.”

    Indeed, in a hardly noticed announcement, the FOMC changed the previously planned upcoming FOMC one day meeting into a two day affair. I hardly think the extra time is to welcome helicopter Ben to his new gig. Rather, it is more likely to discuss the increasing signs of inflation of the commodity, wage, and fiscal flavors. (Note, however, that I do not believe there is wage inflation).

    It is my suspicion that more than a little of the Bullish optimism we have seen over the past 6 months has been incorrectly attributed to the Fed tightening cycle ending. Even more ironically, this regardless of the data showing that markets tend to slide when tightening cycles end.

    To borrow from Dallas Fed President Richard Fisher’s analogy:

    it looks like we are about to go into extra innings against inflation – again.

    Wednesday, February 15, 2006 | Permalink | Comments (8) | TrackBack (0)

    Chart of the Week: S&P500 (12 months), Fed Edition

    As the 12 month chart below reveals, there have been several strong moves off of oversold conditions. Other than the oversold bounce post Katrina, the chatter around each upwards move has involved the expectation that the Fed is (almost) done.


    S&P500 12 months, Fed Theory 


    Source: Ritholtz Research


    What happens as the market comes to realize the Fed may not be so close to finishing?

    Stay tuned . . .


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    Quote of the Day

    “Ignorance is not knowing something; Stupidity is not admitting your ignorance.” 

    -Daniel Turov

    Wednesday, February 15, 2006 | Permalink | Comments (3) | TrackBack (0)

    Connect the Retail Sales Dots

    The usually astute WSJ blows a front page story on yesterday's retail sales data. Actually, you can asign 60% of the blame to whoever came up with the headline, leaving the writer only 40% blameworthy -- he gets many (but by no means all) of the details correct.

    "Consumers went on a postholiday shopping spree in January, a strong sign of economic vigor that increases the likelihood the Federal Reserve will keep raising short-term interest rates.

    The Commerce Department said yesterday that retail sales surged a seasonally adjusted 2.3% in January from December, largely because of gift-card redemptions and abnormally mild winter weather. The January jump followed a tepid 0.4% rise in December. January sales were up 8.8% from a year earlier." (emphasis added)

    That is dead on. Recall my prior perspectives on the holiday retail season as so very dependent on gas prices. (Although December 2005 was revised downwards) Fuel costs have moderated, and we had a fair (not great) holiday season, right within my 3-4% range. 

    However, the writer goes astray here:

    "Coming after an earlier report that employers added nearly 200,000 jobs in January and pushed the unemployment rate down to 4.7%, the retail-sales report was cheered as evidence that the economy has roared back from a fourth-quarter lull."

    Econom_20060214221642 My divergement from the standard reporting is based on their fundamental misunderstanding of how BLS reports data, and what it actually means: Citing the the January sales data as a sign of hiring is simply a fundamental misunderstanding of what seasonal adjustments are. In actual numbers, the economy lost 2.625m jobs in January. When the BLS runs the data through their meat grinder, they seasonally adjust them them to a +193k. I have no problem with that, as it makes sense for BLS to present the seasonal adjustments this way. (You can see more details on the NFP and Unemployment data here). 

    However, financial reporters should be savvier, and realize that 193k jobs were no more created in January then were Enrons' profits created in Q1 2000.  Its an accounting adjustment (Only Enron's were fraudulent, while the BLS data is real -- just seasonally adjusted). Further, the unemployment rate drop has been fully explained as a drop in the Labor Participation Rate, and note an actual decrease in the number of people looking for work.

    But note how putting those two adjusted data points together creates a very false read of the strength of the economy. Its an awesome sucker play, and helps set up the eventual top.

    Back to the Journal:

    "Excluding the 2.9% increase in sales of motor vehicles and parts and a 5.5% rise in gasoline-station sales driven by higher pump prices, the remainder of January retail sales -- everything from department stores to bars -- were up 1.8% from December, when such sales rose just 0.3%."

    Gas sales are hardly signs of economic strength, nor is Detroit giving away cars at cost. Month over month, the gain was less than 2% -- easily explained by a big gift-card season, and the abnormally mild winter weather.

    Further, the WSJ's Justin Lahart counsels us to consider the seasonal adjustments to gift cards. That's right, not unlike NFP for January, the seasonal adjustments made in January exaggerate the actual data. (Note that this adjustment predates the rise of gift cards as a Janaury phenomenon:

    "The gift-card effect may be exaggerated by "seasonal adjustments" made by the Commerce Department. These adjustments, meant to smooth out monthly sales data, assume January's sales will be paltry next to December's. As a result, a small bump to January's sales level could be magnified in the seasonally adjusted numbers that get reported."

    Surprisingly, the person counseling the most restraint about these numbers is Rosalind Wells, chief economist at the National Retail Federation:

    "Ms. Wells of the retail federation and other economists cautioned that two primary drivers of January's sales growth -- balmy weather and gift-card purchases -- will likely evaporate this month, particularly after a blizzard last weekend snowed in consumers throughout the Northeast. Discount chain Target Corp. yesterday said colder weather will hurt February sales and that it now expects sales of stores open more than a year to climb 2.5% to 3.5% in February, down from its previous prediction of 2.5% to 4.5% growth.

    The January bounce was "a one-month shot," Ms. Wells said. "We're likely to see weak February sales because of the blizzards in the Northeast, and then generally I think the economy is going to slow as the year goes on."

    Take this Retail Sales data, tie it into the recent Account Deficit numbers, ands its not to hard to figure out why the Savings Rate is null.

    Obviously, I am talking my own beliefs -- but I am also trying to counter the widespread misread of the data.


    UPDATE: February 15 2006 9:47am

     The NYT is no better:

    But few analysts now fear that consumer spending will fall off a cliff. Job gains and wage growth, typically the leading factor in consumer behavior, appear to be on an upward trajectory after their post-Katrina sluggishness of last fall. The economy added 193,000 jobs in January; wages rose 0.4 percent; and the unemployment rate dropped to 4.7 percent, its lowest level in four and a half years.

    "The deep fundamentals, the personal income numbers, are healthy," said Gregory Miller, chief economist at SunTrust Bank in Atlanta.

    With growth picking up again, economists now expect the Federal Reserve to increase its benchmark short-term interest rate, currently at 4.5 percent, at least once but possibly twice more over the next few months before it brings its tightening cycle to an close. They will be paying particularly close attention today and tomorrow to the Fed's new chairman, Ben S. Bernanke, who is scheduled to testify to Congress for the first time since replacing Alan Greenspan.


    Retail Sales Surge 2.3%, Underlining Economy's Health
    Data Help Dow Industrials Jump 1.3% to Top 11000; Another Rate Increase Likely
    WSJ, February 15, 2006; Page A1

    Buying Power
    Justin Lahart
    WSJ, February 14, 2006; Page C1

    U.S. Trade Deficit Ballooned To a Record in 2005
    GREG HITT and MU
    February 11, 2006; Page A1

     What Fuel Bills? U.S. Consumers Still Spending
    NYT, February 15, 2006

    Wednesday, February 15, 2006 | Permalink | Comments (7) | TrackBack (0)

    New Column: The Street Gets Inflation Threat Backwards

    RealMoneyI have a new column up at, titled  The Street Gets Inflation Threat Backwards.

    It is an expansion of a few recent postshere:  Street Gets Inflation Exactly Backwards and Unemployment Levels and Labor Participation Rate.

    Here's an excerpt: 

    "In my opinion, the majority of economists, strategists and financial media -- the full "punditocracy" -- are exactly wrong on inflation. Indeed, I am hard pressed to think of another item of such grave economic consequence that most of the Street has so backwards.

    The problem is, they are looking for inflation in all the wrong places. The inflation (ex-inflation) crowd has managed to ignore robust price increases across a variety of goods and services. Yet somehow they seem to have found inflation in the one part of the economy where there is almost none: wages.

    One only had to see the market reaction to last week's data on non-farm payrolls, hourly wages and unemployment rate to realize how much the Street has gotten its panties in a bunch.

    The Federal Reserve is acutely sensitive to wage pressure -- much more so than to the commodity price increases we have seen over the past five years. Maybe that's why the FOMC quietly announced that the upcoming meeting, previously planned for March 28, has been expanded to two days. It will now begin on March 27. (I'm sure the extra day isn't for more time to welcome aboard Ben Bernanke.)

    If the Fed falls prey to the erroneous interpretation of wages and jobs, we could see a tightening cycle that goes far beyond what many on Wall Street currently expect. And that would bode extremely poorly for market prospects, both this year and next."

    Regular blog readers will, of course, recognize many of the arguments in the column.


    The Street Gets Inflation Threat Backwards, 2/9/2006 4:02 PM EST

    Friday, February 10, 2006 | Permalink | Comments (10) | TrackBack (2)

    Sourcing the Greenspan Chatter

    This is the article that the Greenspan quote came from that popped the market today; I don't know how accurate it is (holographic image?) but

    Gold price riding high on fear of terrorism, says Greenspan
    Leo Lewis, Tokyo
    February 09, 2006


    "ALAN Greenspan, who stepped down last week as chairman of the US Federal Reserve after 18 1/2 years, has blamed the threat of terrorism for the high gold price, in his first private sector speech since being let off the leash of officialdom.

    According to members of his audience of international investors - watching a holographic image in Tokyo as he spoke in New York - Greenspan said the high cost of gold did not reflect inflation or the strength of commodities, but rather a fear among investors of a major geopolitical conflict. There were people who believed that a nuclear weapon could be detonated within five years, the former American central bank supremo said.

    The low probability of such an event occurring would not necessarily avert a spike in the gold price, he added.

    Greenspan went on to discuss a range of topics, including the problems created by a lack of investment in refining capacity by the oil industry. He said this failure by the oil majors meant that the era of cheap energy was almost surely over.

    The former Fed chairman is also said to have indulged in a moment of self-criticism over the central bank's failure to prevent the market bubble in the late 1990s.

    That may explain Gold's $20 whackage yesterday, but what about all the rest of the metals and commodities?

    Also, if you missed this, you MUST read it:

    Former Fed Chief’s Inscrutable Statements Baffle Wife

    Its a hoot!

    and on the chance the article disappears, I'll archive it after the jump . . .

    Gold price riding high on fear of terrorism, says Greenspan
    Leo Lewis, Tokyo

    ALAN Greenspan, who stepped down last week as chairman of the US Federal Reserve after 18 1/2 years, has blamed the threat of terrorism for the high gold price, in his first private sector speech since being let off the leash of officialdom.

    According to members of his audience of international investors - watching a holographic image in Tokyo as he spoke in New York - Greenspan said the high cost of gold did not reflect inflation or the strength of commodities, but rather a fear among investors of a major geopolitical conflict. There were people who believed that a nuclear weapon could be detonated within five years, the former American central bank supremo said.

    The low probability of such an event occurring would not necessarily avert a spike in the gold price, he added.

    Greenspan went on to discuss a range of topics, including the problems created by a lack of investment in refining capacity by the oil industry. He said this failure by the oil majors meant that the era of cheap energy was almost surely over.

    The former Fed chairman is also said to have indulged in a moment of self-criticism over the central bank's failure to prevent the market bubble in the late 1990s.

    He admitted that at the time he and his colleagues could not see that the notion that they could deflate a bubble with incremental rises in rates was an illusion.

    Greenspan's decision to appear in public so soon after stepping down from the Fed clearly demonstrates that the revered figure in central banking is not one to revel in retirement, after almost two decades at the Fed.

    The 79-year-old is believed to have earned $US120,000 ($162,000) from his one-hour speaking engagement.

    Greenspan revealed that on his first day of retirement last week he told his wife how strange it was to wake up and not worry about what had happened on the Tokyo market the night before.

    The question of where he would deliver his first public speech since retirement had been the subject of fierce debate and intense commercial rivalry.

    Wall Street investment banks, including Goldman Sachs, Morgan Stanley and Citigroup, are understood to have offered to pay him large sums for his time, but they were beaten by CLSA, an aggressive securities firm based in Asia which runs an annual forum on Japan for investors.

    Two years ago Bill Clinton, the former US president, gave the opening speech at the forum - also via hologram - for which he was paid $US200,000.

    From the comfort of an apartment in New York, Greenspan fielded questions from investors and offered some cheer by declaring that after years in the wilderness Japan was a normal economy again.

    The Times

    Wednesday, February 08, 2006 | Permalink | Comments (7) | TrackBack (1)

    The Risk to Equities from Rising Rates

    If risk-free returns on CDs have been returning performance equivalent to risk-laden returns on S&P500, the question some investors are asking themselves is "Why take the risk?"

    That's the issue Justin Lahart explores (inadvertantly) when exploring the issue of how low rates actually are:

    "Even though the Federal Reserve has been raising rates since June 2004, they're low historically. Over the past 50 years, the fed-funds rate (the main overnight rate the Fed controls) has averaged 5.75%. Today's [4.5%] hardly seems onerous . . .


    Ed Hyman, chief economist at research firm ISI Group, points out that those low, long-term yields are also a signal that returns on other investments are expected to be low.

    Consider stocks. Last year, the S&P 500 index had a total return (including dividends) of 4.9%. Meantime, the average rate on a six-month certificate of deposit was 4.6% in December. They're so close, you can imagine investors socking a bit more money in (safer) CDs and a bit less in (riskier) stocks.

    These low expected returns have ramifications on economic prospects. It gives companies less reason to spend money on the equipment or new hires to expand. It gives venture capitalists less reason to fund budding businesses. In short, it discourages investment, and makes economic growth harder to come by as a result.

    Today's low short-term rates may be plenty high."

    Interesting stuff . . .

    Interest-Rate Lowdown
    January 11, 2006; Page C1

    Wednesday, February 08, 2006 | Permalink | Comments (4) | TrackBack (0)

    Tools for Finding a Mortgage

    There was a very helpful article in the WSJ Saturday, titled  Getting Wise to Mortgages. It contains lots of advice and tools to help consumers learn about mortgages, and to shop for the most competitive rates:

    "A few entrepreneurs are developing new tools to help home buyers tackle one of the most confusing projects they face: figuring out whether a mortgage is a fair deal.

    Comparison-shopping for mortgages has long been a job only a masochist could love -- a world of "points," "ARMs" and a barrage of surprise fees. In recent years, it has become tougher amid the proliferation of complex new interest-only mortgages and others designed to enable buyers to delay more of the pain of paying off that debt.

    Now, as interest rates climb, it is important for mortgage borrowers to aggressively shop around for the best terms. Over 10 years, a difference of just 0.125 percentage point on the mortgage rate on a $500,000 loan can rack up more than $6,000 in extra interest payments.

    The problem for borrowers is that lenders have a vested interest in making it tough to compare rival offerings.

    "The general public, they think they know how to shop for mortgages," says Mike Stoffer, who owns a mortgage brokerage in North Canton, Ohio. "They have no clue."

    The Journal recommends several sites to help become more educated:

    The Mortgage Professor: One of the quirkiest tools available is a Web site by a maverick retired finance professor who has made a hobby of skewering mortgage lenders. The site is a compilation of tutorials, calculators and a glossary defining everything from "balloon mortgage" (one that is payable in full at an early date) to "right of recission" (your right to back out of a refinancing within three days of closing).

    • The best defense for consumers is to do some research before starting to shop around. For instance, sites including and not only explain basic terminology, but also provide a range of tutorials and tools.

    The Mortgage Professor ranked the single-lender web sites worth shopping on his own scale; These were the top 3 ranked sites: (47) (46) (42)

    Getting Wise to Mortgages
    New Tools Help Decode Jargon, Sniff Out Deals;
    THE WALL STREET JOURNAL, February 4, 2006; Page B1

    The Mortgage Professor
    :  Mortgage Advice and Counsel

    Sunday, February 05, 2006 | Permalink | Comments (2) | TrackBack (0)

    Barrons picks up "Myths of the Greenspan Era”



    Barron's online edition ran with Monday's Free Lunch: Myths of the Greenspan Era. Once again, the crew there came up with a better title than I:  Cutting Through the Bull About Alan .


    "FEDERAL RESERVE CHAIRMAN GREENSPAN'S imminent retirement has become the largest lovefest since Woodstock. Alas, we cannot avoid adding to the chatter. Besides, how many Fed chairs will retire in our lifetimes? Perhaps we can act as a counterballast to all the accolades and bon mots. Now would be as good a time as any to discuss some of the myths and misunderstandings of the Alan Greenspan era . . ."



    Cutting Through the Bull About Alan
    Barron's, WEDNESDAY, FEBRUARY 1, 2006 3:06 p.m. EST

    Wednesday, February 01, 2006 | Permalink | Comments (3) | TrackBack (1)

    Once Fed Hikes Stop, Markets Fall

    As we digest the Fed statement, let's put yet another Bullish Myth to rest:  Markets do not have an upward bias after a rate tightening cycle ends.

    Instead, we see the end of a hiking cycle occuring towards the end of a business cycle. That implies if not an outright recession, than at least a significant economic slow down occuring quite often.

    What actually has happened at the end of a rate tightening cycle? USA Today commissioned a study from Ned David Research on just that question. NDR's conclusion? 

    "Going back to 1929, the Standard & Poor's 500 was actually lower six months after the last rate increase 71% of the time and down 64% of the time 12 months later, according to data that NDR compiled for USA TODAY...

    [W]hat the bulls see as an all-clear signal is far from a sure thing. "There's quite a bit of talk about the market doing better once the Fed (stops)," says Ed Clissold, senior global analyst at Ned Davis Research (NDR). "However, more often than not the market has struggled after the last rate hike."

    That's not even remotely close to the case promulgated by the Bulls:

    Wall Street is betting big on stock prices heading higher once the Federal Reserve stops raising interest rates. But there's no guarantee it will be a winning bet, history shows.

    For months, market strategists have been trumpeting the fact that stocks usually rise when the Fed ends its rate-increasing campaigns. Many pundits cite the expected end to the current "tightening cycle," perhaps as early as March, as the key catalyst that will boost stocks.

    End of Fed's rate increases may not be good for  stocks


    Sources: Ned Davis Research, USA TODAY research


    Here's the classic example of the statistically unlikely scenario:

    "Jason Trennert, chief investment strategist at ISI Group, says the upward bias in anticipation of the Fed stopping makes perfect sense.

    "You have the best of both worlds," he says. "Before the Fed stops, the economy is still performing well, corporate earnings are still good, and the market benefits from the expectations of the Fed stopping."

    More of the same Goldilocks story. Allow me to remind you that Trennart -- who is otherwise a nice guy -- has been incorrectly predicting the outperformance of Big Caps over Small and Mid-caps for too many quarters to count, as well as a resurgence of Capex spending for even longer. He's been wrong on both accounts.

    There is a silver lining, however:  Since 1980, the Fed has tended to start lowering rates (on average) six months after their final increase.

    And falling rates are usually bullish for stocks... eventually.



    Odds are that stocks will drop once rate-rising stops

    Adam Shell
    USA TODAY, Posted 1/29/2006 10:58 PM

    Wednesday, February 01, 2006 | Permalink | Comments (12) | TrackBack (0)

    The Best Writings of Ben S. Bernanke

    Now that Greenspan has ridden off into the sunset, what do we know about his successor, Dr. Ben Bernanke?  His temperment, economic views, stylistic approaches?

    Actually, quite a lot. Fed Chair Bernanke (first time I wrote that) has been a prolific economic author. For the economic policy wonks out there, the following can be considered Bernanke's Greatest Hits:

    Inflation Targeting: A New Framework for Monetary Policy?
    Research: NBER, Ben S. Bernanke and Frederic S. Mishkin, Jul 1997

    The Global Saving Glut and the U.S. Current Account Deficit
    Analysis: Federal Reserve, Governor Ben S. Bernanke, Mar 10, 2005

    Monetary Policy and Asset Price Volatility
    Research: Federal Reserve Bank of Kansas City, Ben Bernanke and Mark Gertler, 1999

    Should Central Banks Respond to Movements in Asset Prices?
    Research: American Economic Review, Ben S. Bernanke and Mark Gertler, 2001

    Deflation: Making Sure "It" Doesn't Happen Here
    Analysis: Federal Reserve, Remarks by Governor Ben S. Bernanke, Nov 22, 2002

    Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment
    Research: Federal Reserve, Ben S. Bernanke, Vincent R. Reinhart, and Brian P. Sack, Sept 2004

    Inside the Black Box: The Credit Channel of Monetary Policy Transmission
    Research: NBER, Ben S. Bernanke, Mark Gertler, Jun 1995

    The Federal Funds Rate and the Channels of Monetary Transmission
    Research: JSTOR, Ben S. Bernanke, Alan S. Blinder, Sep, 1992

    What Explains the Stock Market's Reaction to Federal Reserve Policy?
    Research: Federal Reserve, Ben S. Bernanke and Kenneth N. Kuttner, Oct 2003


    Hat tip to Roubini Global Economic Monitor

    Wednesday, February 01, 2006 | Permalink | Comments (2) | TrackBack (0)


    The online WSJ writes:

    THE FED'S STATEMENTS reflect how the members of the central bank's Federal Open Market Committee perceive the economy. The slightest changes are scrutinized for clues about where interest rates may be headed. With Greenspan stepping down and Bernanke set to replace him, January's statement will be read particularly closely.

    The Jan. 31 statement announced that the Fed was raising its key short-term interest rate by one-quarter point to 4.5%, its 14th increase in a row. In a sign that rate increases may be nearing an end, the Fed also removed the word "measured," which had come to signal steady quarter-point increases ahead. Below is a look at differences between the January statement and the December one.


    Click for larger graphic

    courtesy of WSJ


    One More for the Road
    WSJ, Jan. 31, 2006

    Tuesday, January 31, 2006 | Permalink | Comments (3) | TrackBack (0)

    New Column: Myths of the Greenspan Era

    RealMoneyMy new column is posted at, titled Myths of the Greenspan Era. Its a modest look at some of the economic urban legends that have sprung up around Easy Al.

    Based on yesterday's Free Lunch discussion, it includes additional charts and data. Its also much less critical than our analysis back in 2004.

    Here's an excerpt: 

    "Myth 1: Greenspan Whipped Inflation: This is by far the most pervasive fallacy of the era. It has added to the Maestro's legend -- undeservedly so, in my opinion. This is probably the myth that's easiest to disprove.

    Numerous factors have led to low inflation over the past few decades; none of them have much to do with Greenspan.

    To understand where you are, you must consider how you got here. And when it comes to whipping inflation, it all begins with Chairman Paul Volcker.

    As the chart of long-term interest rates reveals, inflation was spiking in the late 1970s. The oil embargo of the early '70s started an inflationary spiral that threatened the entire economy. Growth was anemic, and Japan was a growing threat to the industrial heartland. A post-Watergate and post-Vietnam malaise hung over everything. It was not a particularly joyous period in the U.S. When Volcker was appointed Fed chairman, inflation was in the double digits, and growth was stagnant. That combination came to be known as "stagflation."

    Fed Chair Volcker aggressively changed the way the Fed attacked inflation. He forced some unpleasant but necessary monetary medicine down the gullet of the American economy.

    No helicopter drops for Volcker: The first thing he did was idle the Treasury Department's printing press. By limiting the growth of money supply -- and abandoning interest rate targeting -- he made it clear that no matter how painful in the short term, he was going to get runaway prices under control. Inflation, which had peaked at 13.5% in 1981, was down to 3.2% by 1983. The U.S. has been enjoying the fruits of his labor ever since."

    Its on the free site. Go forth and read!.


    Myths of the Greenspan Era, 1/31/2006 11:08 AM EST

    Tuesday, January 31, 2006 | Permalink | Comments (6) | TrackBack (0)

    Free Lunch: Myths of the Greenspan Era

    Federal Reserve Chairman Greenspan’s imminent retirement has become the largest love-fest since Woodstock. Alas, we cannot avoid adding to the chatter. Besides, how many Fed Chairs will retire in our lifetimes? Perhaps we can act as a counter-ballast to all the accolades and bon mots. Now would be as good a time as any to discuss some of the myths and misunderstandings of the Alan Greenspan era:

    Myth 1 Greenspan whipped inflation: This is the most pervasive-yet-easiest to disprove Fed Chair legend. As the nearby chart of long term interest rates reveals, inflation spiked in the late 1970s. Paul Volcker became Fed Chair during that period of ugly stagflation. He aggressively changed the way the Fed attacked inflation, and the U.S. has been enjoying the fruits of his labor ever since.

    Myth 2 Greenspan’s flexibility met all challenges: Flexible? Hardly. The Fed Chair’s response to every challenge has been the same: inject more liquidity into the system. That’s why Money Supply has risen so dramatically over the past 18 years (M3 included), and why rates are down to unnaturally low levels. To be considered flexible, you would need more than one move in your bag of economic tricks.

    Myth 3 The Plunge Protection Team: After the 1987 crash, traders claimed the market “mysteriously” managed to stop its sickening fall. While others have laid this myth to rest previously, let’s go right to the source of this one. The Dow had dropped from 2,400 to almost 2,200 on Friday, and then plummeted to almost 1,600 on Black Monday. A 33% peak-to-trough drop is no sign of an invisible hand: That’s a massive, capitulatory distribution which exhausts sellers. That correction brought out bottom-fishing fools and heroes alike – no Plunge Protection Team necessary.

    Myth 4 The Greenspan Put: While the concept of the “Put” is alive and well, I do recall a recent 78% plunge in the Nasdaq. As of Big Al’s 2nd to last day as Chairman, the Nasdaq was still down close to 60%. If that’s the kind of capital destruction that exists with the “Put,” its really not worth all that much. Indeed, the brutal crash makes it kinda hard to argue that the Put is – or ever was – alive and well.

    Myth 5 Greenspan as Economic Sage: We laid this fable to rest in 2004 (Ignore the Cheerleader-in-Chief).

    One has to wonder why so many acolytes believe you can get something for nothing. Yet Greenspan’s legacy is based on the Free Lunch: easy money, and lots of it. Yet I recall the very first lesson in Economics: “There is no Free Lunch.”

    Much of the Greenspan myth is actually the result of his fortuitous timing: He started his gig as head honcho 5 years into the biggest Bull Market in history, and even before the crash, his reputation had been cemented.

    Despite the saying, people still confuse a bull market with genius.

    Monday, January 30, 2006 | Permalink | Comments (15) | TrackBack (1)

    Chart of the Week: 10 year Treasury 1974-2006

    Greenspan garners all the credit for the low interest rates of the past 20 years. We believe the chart below proves otherwise. The Oil shock in the 1st half of the 1970s gave way to inflation shock of the 2nd half.


    10 year Treasury 1974-2006, Constant Maturity

    Source: RCP, Economagic


    When Volcker was appointed Fed Chair, inflation was in the double digits and growth was stagnant. He forced unpleasant medicine down the gullet of the American economy, limiting the growth of the money supply and abandoning interest rate targeting. Inflation, which had peaked at 13.5% in 1981, was down to 3.2 percent by 1983.



    Random Items:

    Americans Say Economy Is Getting Worse

    The Reform of October 1979: How It Happened and Why

    Technical Evidence Builds That We're Near a Top

    Media Lesson: How the not to cover the economy


    Ignorance is the opposite of bliss

    Partisans Adept at Ignoring Facts, Study Finds


    Quote of the Day: 

    “A wise observer of the economic scene once commented that ‘what can be left to later, usually is – and then, alas, it's too late.’”

    -Paul Volcker, Federal Reserve Chairman, 1979-87

    Monday, January 30, 2006 | Permalink | Comments (7) | TrackBack (0)

    Has the Fed Kept Inflation in Check?

    Panzner answers no:

    click for larger graph


    Inflation has accellerated since the 1929 crash . . .

    Monday, January 16, 2006 | Permalink | Comments (12) | TrackBack (0)

    Danger time?

    20060114issuecovus400This week's Economist pulls the gloves off and laces into Mr. G pretty good. In a pair of articles, they diussect the US economy, analyze it shortcomings, and hold Greenie largely responsible for a significant percentage of these economic problems:

    "Mr Greenspan's departure could well mark a high point for America's economy, with a period of sluggish growth ahead. This is not so much because he is leaving, but because of what he is leaving behind: the biggest economic imbalances in American history."

    And they're just getting started. They note that "the Fed's policies of the past decade look like they are having painful long-term costs." 

    Further, the issue is not a housing bubble; rather, its the over reliance on mortgage equity extraction as the key source of GDP growth:

    "The problem is not the rising asset prices themselves but rather their effect on the economy. By borrowing against capital gains on their homes, households have been able to consume more than they earn. Robust consumer spending has boosted GDP growth, but at the cost of a negative personal saving rate, a growing burden of household debt and a huge current-account deficit... Part of America's current prosperity is based not on genuine gains in income, nor on high productivity growth, but on borrowing from the future."

    Csf117 Next up:  weaker than usual job creation and sluggish real wage growth: 

    "American incomes have increased much more slowly than in previous recoveries. According to Morgan Stanley, over the past four years total private-sector labour compensation has risen by only 12% in real terms, compared with an average gain of 20% over the comparable period of the previous five expansions. Without strong gains in incomes, the growth in consumer spending has to a large extent been based on increases in house prices and credit."

    Hardly the robust economic scenario made out by so many cheerleaders in the U.S.

    The Economist reserves their harshest criticism for the man himself, noting "The accolades bestowed upon Alan Greenspan ahead of his retirement on January 31st have a strong whiff of irrational exuberance."

    The rest of the articles details the shortcomings and failures of Mr. Greenspan and his policies. It is must reading for anyone even remotely curious how we got into the situation we currently find ourselves: The current belief by many that the economy is robustm inflationis contained, and the structural economic imbalances are merely bothersome, not outright dangerous.

    In the words of Austrian economist Ludwig von Mises: “It may sometimes be expedient for a man to heat the stove with his furniture. But he should not delude himself by believing that he has discovered a wonderful new method of heating his premises.”

    Danger time indeed, on this Friday the 13th . . .

    Danger time for America
    Jan 12th 2006
    From The Economist print edition

    Monetary myopia
    Jan 12th 2006
    From The Economist print edition

    Friday, January 13, 2006 | Permalink | Comments (17) | TrackBack (1)

    Read it here first: The World Isn't Flat, but Its Yield Curve May Be

    Earlier this week, we brought to your attention "A World of (mostly) Flattening Yield Curves."

    In the Sunday NYTimes today, Dan Gross does a nice job on the same subject:

    "But there are signs that the United States no longer has a monopoly on the conundrum. In recent months, the yield curves in Japan and Germany, the second- and third-largest economies in the world, have been flattening, while the yield curve in Britain has already inverted. "Long-term interest rates are even lower in Europe and Japan than they are in the U.S.," said Kenneth Rogoff, a professor of economics at Harvard.

    Yet these economies lack some of the structural features of the United States economy. And each is at a different phase in the business cycle. While America may very likely have a slowdown in growth in the second half of this year, Mr. Rogoff says, Europe and Japan are likely to gain economic strength as the year progresses.

    What gives?

    "The conundrum is global," said Lakshman Achuthan, managing director at the Economic Cycle Research Institute, based in New York. The same factors that are influencing the interest rate climate in the United States are having similar effects on overseas bond markets."

    Of course, no discussion of Yield Curve flattenings or inversions would be complete without a graphic:


    click for larger graphic


    courtesy of NYT


    I will point out that these curves are not as flat as the ones Panzner created, using the 2 and the 10 year Treasuries. (Dan, what duration are the treasuries used for the NYT charts?)

    UPDATE: January 9, 2005 5:58am

    I somehow missed the legend at bottom -- The NYT chart show the full yield curve for the entire maturity (3 months outward), versus our prior chart showing the spreads between two and 10 year maturities over time.


    The World Isn't Flat, but Its Yield Curve May Be
    Economic View
    NYT, January 8, 2006

    Sunday, January 08, 2006 | Permalink | Comments (2) | TrackBack (0)

    NFP & Operation Quicksilver

    Today's Non Farm Payrolls data is due at 8:30, and the consensus is for 215,000.
    (Why break the streak? I'll take "the under" again, please).

    This Payroll  report will bring into focus two elements we haven't discussed much recently:

    Good News is Bad News
    We are at one of those funny junctures where the Market perceives bad news as good, and vice versa.

    That implies a modestly weak payroll report will be perceived as support for the notion that the Fed has done their job in cooling the economy down just enough so that inflation is contained.

    If we see a number between 175k-225, it will support those in the "Two & Through" camp; 125-175k will benefit the bettors on "One & Done." Anything below 125k, or above 225k, and its "How Rude/We're Screwed." (The downside number would be a real unexpected surprise).

    Not that type of Inflation
    My take on today's Payroll numbers? Unless its a real outlier, I don't believe it will matter all that much.


    Because the Fed is fighting at *Calais, and not Normandy.

    It seems their primary inflation concern remains wage inflation -- which is nowhere to be found.

    I see Inflation today being driven by two factors -- Asian commodity demand, and fixed structural domestic costs (insurance, health care, etc.) in the U.S. I'm not sure how much the Fed can do about either, short of causing a world wide slowdown.

    So unless today's Payroll numbers are a blow out -- or a disaster -- it probably won't make all that much of a difference to the them.

    * During WWII, the Allies engaged in an enormous and risky military deception before D-Day: Operation Quicksilver. Through a variety of feints and counter-intelligence, Allied Commanders made the Germans believe the D-Day invasion was going to hit either Calais, France -- or Norway. While the bloody D-Day invasion met stiff resistance at Normandy, there was no counterattack from the German Panzer Units .

    Friday, January 06, 2006 | Permalink | Comments (6) | TrackBack (0)

    Fed Minutes

    The Fed announced their plans today to “only invert the Yield Curve somewhat,” rather than the deeper and more extensive inversions some traders feared.

    The minutes revealed a debate between the two camps: The Hawks wanted to invert the Yield curve extensively, while another, more dovish group only wanted to see the flat curve inverted more moderately.


    UPDATE:  January 4, 2005  6:13am

    Front page WSJ article states "Fed officials are less worried about inflation and thus may be nearing an end to their campaign to raise rates, minutes of their December meeting suggest."

    Joanie has a very different take on both the minutes and the markets reaction:

    "I read it in its entirety.  Quite boring, as a matter of fact; nothing new at all.

    They say that the economy is on solid ground across the board, the only slight slippage mentioned at all was a mention of a bit of cooling in housing. Employment and output are right up there and inflation, of course, remains in check.

    The minutes go on forever, rehashing a lot of stuff we have known for eons. Some think we need more tightening, but there is no consensus as to how much. Bottomline, they are monitoring the data carefully. And will act accordingly.

    Look. We knew all that; a couple or so more and finito. I found the minutes totally uninspiring and lacking in any detail that is not already well hashed out in the press.

    HOWEVER:  The tape says that they were dovish.

    But here’s the biggest question of all:  It took me a solid 20 minutes to read that junk all the way through as it doesn’t quite read as easily as the Daily News.  So can you please tell me how they put the pedal to the metal at precisely 2 p.m.?  I mean, you couldn’t even get on the website to read it that fast.

    Bottomline:  Earlier, we came within .30 of putting in a Oitside Down Day.  They rallied here because they could. The minutes are the excuse."

    Tuesday, January 03, 2006 | Permalink | Comments (13) | TrackBack (0)

    A World of (mostly) Flattening Yield Curves

    Lately,  we've been discussing the Yield Curve, its flattening and inversion and how its different this time (not). This has been termed a "conundrum" by outgoing Fed Chair Alan Greespan.

    Many commentators have cited foreign buying of longer-term treasuries as the reason for this "conundrum." While the U.S. yield curve has flattened considerably since its August 2003 peak,that period hardly marks the beginning of foreign purchases of US Treasuries.

    Further, if we take a fresh look at curves elsewhere, we see this issue is not limited to the U.S. As the chart below reveals, Yield curves around the globe are flattening.

    While numerous rationales try to explain away the US inversion as an anomaly, the excuse making ignores the small fact that the US is not the only country with a flattening Yield Curve: So too are Japan, UK, Germany, Switzerland, Canada and Australia. 

    The yield curve inversion naysayers have yet to explain how foreign purchases of U.S. Treasuries are flattening curves elsewhere also.

    click for larger graph


    Source: Mike Panzner, Rabo Securities


    Funny, those who try to convince you the Yield Curve doesn't mean anything aren't mentioning this inconvenient factoid of Global Curve Flattening.


    To paraphrase Panzner:  "Given that spreads between long and short-term rates in many major bond markets (including Japan) have also fallen recently, perhaps "this time" is not so different after all? Could it be that global bond markets are anticipating an impending slowdown?"

    Here's a typical set of explanations:

    1) stock-market investors fled the crash of 2001, and their alternative-investment strategies have soaked up the supply of bonds and other fixed-income securities.

    2) China and other Asian countries are parking their dollars to drive up the value of the U.S. currency and keep their export-driven growth booming.

    3) U.S., European and Japanese populations are aging, and with age comes an investment preference for security and income.

    4) prices for everything except fossil fuels are being held down by productivity increases, international competition and excess manufacturing capacity.

    -Peter Morici, international economist at the University of Maryland's business school

    At first blush, these all appear reasonable. However, a closer look reveal the flaws in each of these explanations:

    1) This is belied by the enormous amount of cash and cash equivalents -- trillions of dollars in money market accounts -- hardly equates to "soaking up bond supply;" And, the crash began in 2000;

    2) Foreign buying of US bonds cannot explain flattening yield curves elsewhere (See  chart above);

    3) True dat; Now what about the very young populations in the rest of Asia and the Middle East? Or do we just pretend they are not market participants, and ignore the fact their equity markets have all soared in 2005?

    4) Astonishingly misleading statement: Nothing is going up except oil? How about food, building materials, education costs, industrial metals, healthcare, raw goods, insurance, housing, precious metals -- they all have risen dramatically.

    While most goods have gone up in price, while a handful of items have come dwn. When we talk about electronics, note that the mechanism that brings their proces down is an economy of scale. The first few units are prohibitively expensive, essentially paying for the factories. The next wave are some what cheaper, and by the thrid iteration, they become mass produced and much less expensive. Think Plasma screens:  They have all plummeted in price -- excepting, of course, for the one screen that I want.


    For the numbers geeks, here are the actual changes in the 10-year vs. 2-year government bond yield spreads for selected countries since August, 2003 (which was the most recent major peak, based on weekly data, in the U.S. spread):

    Country 8/29/03
    Spread %
    Spread %
    (Positive Value
    = Flattening)
    US +2.496 -0.009 +2.505
    Germany +1.604 +0.447 +1.157
    Japan +1.264  +1.188 +0.076
    Switzerland +2.186 +0.506 +1.680
    UK +0.438 -0.091 +0.529
    Canada +1.773 +0.118 +1.655
    Australia +0.557 -0.020 +0.577


    UPDATE 1 JANUARY 6, 2005, 1:31pm

    Check out this Sunday's NYT for more on this phenomena . . .

    UPDATE 2 JANUARY 8, 2005, 8:31am

    This is in today's Sunday NYT

    The World Isn't Flat, but Its Yield Curve May Be
    Economic View
    NYT, January 8, 2006>


    Michael Panzner, Rabo Securities

    Scatter Shots
    THOMAS G. DONLAN (Editorial Commentary)
    Barron's, MONDAY, JANUARY 2, 2006

    citing Peter Morici, international economist at the University of Maryland's business school

    Tuesday, January 03, 2006 | Permalink | Comments (7) | TrackBack (3)

    Gold & The Wizard of Oz

    Terrifically amusing take on Gold, via RaJa's Jeff Saut:

    "We thought a lot about gold over the holiday as we watched “The Wizard of Oz.”

    Now, most people know The Wizard of Oz as one of the most popular films ever made.  What is little known, however, is that the book it was based on was an economic and political commentary surrounding the  debate over “sound money” that occurred in the late 1800s. Verily, L. Frank Baum’s book was penned in 1900, following unrest in the agriculture arena (read: farmers) due to the debate between gold, silver, and the  dollar standard.  The book, therefore, is supposedly an allegory of these historical events, making the  information easier to understand.  In said book, Dorothy represents traditional American values. The  Scarecrow portrays the American farmer, while the Tin Man represents the workers and the Cowardly Lion depicts William Jennings Bryan. Recall that at the time, Mr. Bryan was the official standard bearer for the  “silver movement,” as well as the unsuccessful Democratic presidential candidate of 1896 (he was also a  main character in the Federal Reserve Act of 1913). Interestingly, in the original story Dorothy’s slippers  were made of silver, not ruby, implying that silver was the Populists’ solution to the nation’s economic woes.

    Meanwhile, the Yellow Brick Road was the gold standard and Toto (Dorothy’s faithful dog) represented the Prohibitionists, who were an important part of the silverite coalition. The Wicked Witch of the West  symbolizes President William McKinley and the Wizard is Mark Hanna, who was the chairman of the Republican Party and made promises that he could not keep.  Obviously “Oz” is an abbreviation for “ounce.”

    As we watched the movie we thought how appropriate an apologue for our current environment given the recent action of gold, silver, the dollar, the T’Bonds.  This time, however, the “man behind the curtain” is Alan Greenspan, to which we are paying little attention.  What we are paying attention to is the charts, since in this business price is reality.  Consequently, when we look at the “gold standard” of our era, namely the dollar, the picture is still not a pretty one, even after its recent rally.  As a sidebar, it should be noted that before 1873 the U.S. dollar was defined as consisting of either 22.5 grains of gold or 371 grains of silver.  This set the legal price of silver in terms of gold at roughly 16:1 and put the country on a gold/silver bimetallic  standard. Since both metals had other uses than just coinage, whenever the ratio got out of whack, rational people would buy the cheaper metal and take it to the mint to coin.  That provided a natural stabilizing arbitrage. With the 1873 Coinage Act, however, the silver dollar was omitted, effectively shifting the country  from a bimetallic to a gold standard.  Other countries soon followed this shift and as tons of silver were unloaded, the market silver price of gold rose from 16:1 to 40:1. 

    The result was that the dollar was now linked to a metal that was getting scarcer and scarcer."

    Who knew?


    Investment Strategy
    by Jeffrey Saut
    December 27, 2005

    Following the Yellow Brick Road: How the United States Adopted the Gold Standard
    Federal Reserve Bank of Chicago
    Economic Perspectives, 4th Quarter, 2002

    Sunday, January 01, 2006 | Permalink | Comments (3) | TrackBack (2)

    2 Studies on the Flattening Yield Curve

    A reader asked about prior studies on a flattening or inverting yield curve, wondering  "what have they concluded?"

    Quite a few other analysts have looked into the question. Here are two worth considering:

    Bill Gross, who manages the world's largest Bond fund -- and therefore better know about this stuff --  featured the chart below last month.

    Gross' conclusion? "By the time 10-year and 2-year Treasuries reach parity, as is almost the case now, the economy is typically slowing and the Fed is at or near the end of its tightening cycle."

    Here is his relevant chart:


    click for larger graphic


    Courtesy of PIMco


    Gross also observed that "Economists/investment managers are aware of the potency of a flattening yield curve (shown in Chart above). . . Only [former Fed Chair] Volcker, with his need to strangle inflation out of the system, persisted into negative yield curve territory for longer than a few months."


    Further, I happened to come across this commentary -- A Study on the Flattening Yield Curve -- of post-1970 inversions.

    The study's generalized conclusions?

    1. Recessions have been preceded by yield curve inversions since 1970.
    2. lead time averages over 40 weeks.
    3. The S&P 500 does not do well when the yield curve is inverted (performance measured over the entire span of the inversion).

    The chart accompanying that commentary  shows yield curve inversions relative to the S&P500.


    click for larger chart


    See the rest of the charts form various studies here.


    UPDATE: December 29, 2005  1:30PM

    I have made repeated references to never relying upon one lonesome single indicator, burt some of the newer reader smay have missed them. For those of you haven't done so yet, please see Single vs. Multiple Variable Analysis in Market Forecasts . . .

    UPDATE 2: December 29, 2005  3:03PM

    Dave Altig of MacroBlog fame suggests NY Fed's Arturo Estrella yield curve primer:  The Yield Curve as a Leading Indicator. Its another excellent (if somewhat jargon laden) source.

    Takin’ It To The Blog
    Bill Gross
    PIMCo Investment Outlook, November 2005

    A Study on the Flattening Yield Curve
    Ron Griess
    The Chart Store,  December 13, 2005

    Thursday, December 29, 2005 | Permalink | Comments (17) | TrackBack (0)

    Explaining Yield Curve Inversions

    The Yield Curve briefly inverted -- twice -- Monday. As we noted yesterday, the deeper and longer a curve remains inverted, the more potentially significant it is.

    That factoid has been overlooked by many commentators. Following yesterday's post about what an inversion means, it became apparent that there is alot of confusion about the implications. So far, all we have is a brief inversion -- which, for the moment, is merely a warning.

    The best explanation I've read for what the Inverted Yield Curve may mean to the economy and markets comes from Lacy Hunt, a veteran Wall Street economist who formerly worked at the Dallas Fed:

    "There has been a lot written about the flattening yield curve, though most people don't understand what causes it.

    The narrowing spread between yields is a superb leading indicator but shouldn't be observed in a vacuum -- no lone silver bullet can take down the economy. A steep flattening of the yield curve is a sign that the Fed is in the later stages of tightening its monetary-policy belt. It's part of the broader process. But once it occurs, it does have its own implications for the economy and the markets.

    Treasury yields should be viewed in concert with central-bank policy and changes in the availability of money and credit. The Fed influences supply and demand for money when it raises the fed-funds rate, since it pushes up money-market yields. To boost the funds rate, the Fed has to cut down on total reserves -- money that banks are required to keep around for backing up deposits.

    That reduces how much money can be supplied to people and businesses for borrowing and investing and it crunches the availability of credit that Americans now rely heavily on to keep up their spending habits. Banks' profits, meanwhile, are crimped because they can't make easy money by borrowing at low, shorter-term rates and lending at high, longer-term rates -- one version of the time-honored carry trade. Higher rates can grind the borrowing and lending process to a halt -- or it can reverse, where people pay their loans with money they normally would spend elsewhere. All told, economic growth is stunted.

    The yield curve is flattening because Fed policy is working -- it's not a surprise that a higher fed-funds rate is followed by slowing growth in money supply and a narrowing in the spread between short- and long-term Treasury yields. This is clearly evident as 2005 draws to a close: Total reserves fell 4.1% in the past 12 months, and the contraction has happened at a faster pace in recent months because of the cumulative impact of 13 Fed rate increases. M2 money supply -- cash, deposits and short-term assets such money-market funds -- increased a paltry 3.4% in the last 12 months, the slowest growth in 10 years.

    While the flattening yield curve is part of the process, it shouldn't be taken lightly. This barometer narrowed significantly prior to all of the recessions since 1954, as well as two major business slowdowns in 1967 and 1995. In the middle of those slowdowns, the economy grew at annual rates of 1.6% and 0.9%, respectively. Only quick and decisive Fed action prevented worse conditions. Since 1954, growth in M2 when adjusted for inflation slowed dramatically in the four quarters right before recession. The same thing happened with the slowdowns of 1966 and 1995. That is why both the yield curve and M2 supply are widely considered excellent leading indicators.

    Growth of less than 1% in real M2 in the past four quarters, combined with a sharp contraction in total bank reserves, reinforces what the yield curve is telling us: The economy is headed for a slowdown. That means either less inflation, less real growth, or some combination of the two."

    I hope that's not too wonky; it is as clear an explanation I've ever read, without dumbing it down too much. Note that the past 4 recessions were preceded by a Yield Curve Inversion, and prior flattenings have predicted a slowdown.


    Here's a chart from today's WSJ:
    click for larger graphic


    chart courtesy of WSJ

    UPDATE:   December 31, 2005  5:13am

    A reader asked for a study on inversions and recessions. Marketwatch reported that Merrill Lynch just released a study (on Friday!) on the subject: 

    "The historical record speaks for itself," said Merrill Lynch analysts in a report published Friday.

    "In the past 30 years, the yield curve has inverted five out of the eight times the Fed has been tightening monetary policy. Each of those five times an economic recession has ensued one year later -- our fear (though not our base case) is that this time will be no different."

    If anyone has access to this, please contact me about  sending it.




    Examining an Inversion
    WSJ, December 23, 2005

    Yields on Bonds Invert, Reflecting Unease About Economy's Future
    THE WALL STREET JOURNAL, December 28, 2005; Page A1

    Stocks could see rebound on data
    Economic data and 4Q earnings to greet the New Year
    Jasmina Kelemen
    MarketWatch, 5:01 AM ET Dec. 31, 2005

    Wednesday, December 28, 2005 | Permalink | Comments (17) | TrackBack (2)

    Inverted Yield Curve: Its different this time (not)

    The yield curve, as measured by the ratio between the 10 and 2 year treasuries, is merely a few ticks away from inverting. This is something worth paying close attention to.

    What's the significance of an Inversion?

    It reflects a decreasing demand for capital (low long rates), and can also be read as the Bond Market's apprehension of a slowing economy  -- why buy short Bonds if they are about to get even cheaper?

    While not every inversion leads to a recession, every recession has been preceded by an inverted yield curve. Thus, it can be described as a necessary but not sufficient factor for a subsequent recession. 

    According to a Dow Jones article in today's WSJ:

    "Bond analysts aren't holding out much hope that the 10-year Treasury note will end 2005 with a bang, but the yield curve may ignite some fireworks.

    The benchmark 10-year yield, which is sitting just below the 4.4%-4.6% range it had been confined to for more than a month, probably won't stage a significant breakout during the last trading week of the year, analysts say.

    But it's a different story for the two-year note. Amid upcoming supply as well as widespread belief that the U.S. Federal Reserve will raise rates one or two more times, the two-year yield is likely to head higher. A bond's yield rises as its price falls.

    When the two-year note underperforms the 10-year issue, the difference between these notes' yields -- which slid to 0.01 percentage point last week -- has the potential to disappear altogether, and the two-year note's yield can even surpass the yield on the 10-year.

    When shorter-dated yields overtake their longer-dated counterparts, the yield curve is described as inverted. It is a bond-market rarity that has historically foreshadowed recession."

    The 2/10 relationship -- and whether it becomes inverted -- has been one of several traditional harbingers of ill economic winds. There has already been Inversion "in the shorter end of the yield curve, with two-year notes yielding about 0.04 percentage point more than five-year notes late last week."

    Fed Chairman Alan Greenspan has noted that "its different this time." He has challenged the view that "inversion signals economic trouble, pointing out that the shape of the curve is less predictive than it once was."

    Further, the depth and duration of the inversion also plays a hand in its predictive ability:

    "While an inversion between two- and 10-year "seems in the cards," some bond managers expect the flip-flop in yields to be minimal -- just 0.1 to 0.15 percentage point over the next few months before things turn back around. A brief, shallow inversion won't signal any marked slowdown in the economy. Over the past several decades, the yield curve has had to invert by two percentage points or more before a recession materialized.

    One bond portfolio manager noted that the market seems to be priced for the Fed to start easing rates as soon as it stops tightening them." (emphasis added).

    Any good technician will tell you never to anticipate a breakout or technical signal. Thus, declaring a recession to be inevitable based on an imminent inversion -- or a non-recession based upon a short, mild inversion -- may not be the best market call.

    Nonetheless, any inversion -- even a shallow and brief one -- would ratchet up an already elevated anxiety level in the bond market, as "investors worry about a cooler housing market, inflation and energy prices, particularly high home-heating bills" notes the Journal. And that's before getting to Mortgage Equity Extraction, Current Account Deficit, a shopped out consumer, an expensive ongoing War, and assorted ills left over from the equity bubble's collapse.

    An inverted yield curve is not a guarantee of a recession, but it is nonetheless a worrisome thing. If it doesn't foretell a recession, its not because "its different this time;" rather, its more likely because only some conditions precedent will have been met . . . 


    UPDATE:   December 27, 2005  5:13pm

    That didn't take very long, did it?

    Stocks tumbled Tuesday as the bond market gave signals that in the past have preceded economic slowdowns. The Dow Jones industrial average lost more than 100 points.

    The yield curve, the spread between the yields of short-term and long-term bonds, inverted for the first time in five years. That means short-term interest rates were higher than long-term interest rates. Investors have been watching the yield curve closely because, in the past, inverted yield curves have preceded recessions.

    The yield on the 10-year Treasury fell to 4.341 percent, while the two-year Treasury note closed at 4.347 percent.

    Normally, lenders receive higher interest when they commit their money for a longer time. A surge in demand for short-term credit can flatten or invert the yield curve.

    The last time the yield curve was inverted was 2000, Charles H. Blood Jr., senior financial markets analyst at Brown Brothers Harriman & Co. At the time, "it served its classic function of a warning," he said.

    Investors have been watching for months as bonds' long-term yields and short-term yields grew closer. "Although an inverted yield curve does not always imply an economic recession, it has predicted a profit recession 100 percent of the time," Merrill Lynch's North American Economist David R. Rosenberg said earlier this month.

    Dow Finishes Down 106 at 10,778, Nasdaq Finishes Down 23 at 2,227 As Yield Curve Inverts


    Yield Curve May Become Inverted
    Rate of the 2-Year Treasury Is Likely to Rise as 10-Year Flattens, Sparking Concern
    DOW JONES NEWSWIRES, December 27, 2005

    Tuesday, December 27, 2005 | Permalink | Comments (10) | TrackBack (5)

    Federal Reserve Chairman George Costanza

    Barron's Alan Abelson's Christmas wish list has a few gifts for the outgoing and incoming Federal Reserve Chairmen:

    "To Alan Greenspan: a secluded mountaintop on which to reflect and repent.

    To his successor, Ben Bernanke, an infallible formula for setting the country on the right financial path: whenever faced with making a critical decision, think, What would Alan Greenspan have done? -- and do exactly the opposite."

    1) Ask WWGD?
    2) Then go the other way?

    I have to agree -- its brilliant in its simplicity. If most everything Greenspan has done has worked out disastrously, then Bernanke should do the opposite!

    Wait a second -- that sounds vaguely familiar . . .

    Waitress : Tuna on toast, coleslaw, cup of coffee.
    George : Yeah. No, no, no, wait a minute, I always have tuna on toast. Nothing's ever worked out for me with tuna on toast. I want the complete opposite of on toast. Chicken salad, on rye, untoasted ... and a cup of tea.
    Elaine : Well, there's no telling what can happen from this.
    Jerry : You know chicken salad is not the opposite of tuna, salmon is the opposite of tuna, 'cos salmon swim against the current, and the tuna swim with it.
    George : Good for the tuna.
    ( A blonde looks at George )
    : Ah, George, you know, that woman just looked at you.
    George : So what? What am I supposed to do?
    Elaine : Go talk to her.
    George : Elaine, bald men, with no jobs, and no money, who live with their parents, don't approach strange women.
    Jerry : Well here's your chance to try the opposite. Instead of tuna salad and being intimidated by women, chicken salad and going right up to them.
    George : Yeah, I should do the opposite, I should.
    Jerry : If every instinct you have is wrong, then the opposite would have to be right.
    George : Yes, I will do the opposite. I used to sit here and do nothing, and regret it for the rest of the day, so now I will do the opposite, and I will do something!
    ( He goes over to the woman )
    George : Excuse me, I couldn't help but notice that you were looking in my direction.
    Victoria : Oh, yes I was, you just ordered the same exact lunch as me.
    ( G takes a deep breath )
    George : My name is George. I'm unemployed and I live with my parents.
    Victoria : I'm Victoria. Hi.


    Something for Everyone
    Barron's MONDAY, DECEMBER 26, 2005

    The Opposite (episode #86)
    Writers: Andy Cowan, Larry David, Jerry Seinfeld
    Originally aired: Thursday May 19, 1994 on NBC

    The Opposite

    Saturday, December 24, 2005 | Permalink | Comments (1) | TrackBack (0)

    Economists React to Fed


    The Federal Reserve, as expected raised interest rates for the 13th consecutive time Tuesday, lifting the federal-funds rate by a quarter percentage point to 4.25%. The central bank suggested it would raise rates again, but also hinted that it is less certain on its future rate actions than it has been in over a year. In the accompanying statement, the Fed said growth remained "solid", inflation excluding food and energy prices had "stayed relatively low," and inflation expectations were contained. But it also warned that the possibility of further erosion of spare productive capacity and high energy prices "have the potential to add to inflation pressures."

    What do economists and other analysts make of the changes? Here's a sample of their commentary:

    * * *

    The Fed has finally taken the step that we have been pointing to for a while, in separating the two concepts of reaching neutrality and finishing the rate cycle. They kept "measured," as we thought they might, but now it refers to "some further measured policy firming" as opposed to removing accommodation at a measured rate. So, rather than being on automatic pilot in raising rates toward neutral, the FOMC now sees itself in the second stage of the rate hike cycle -- further moves will be perceived by Fed officials as taking policy toward a restrictive stance.

    -- Stephen Stanley, RBS Greenwich Capital

    * * *

    The message from the FOMC appears to be that barring a major change in the tone of economic data, another 25bp tightening move will be implemented at Chairman Greenspan's last meeting on January 31. At that time, it is quite possible that the "measured phrase" will be jettisoned, leaving incoming Chairman Ben Bernanke with a clean slate for the next meeting on March 28. Our own view remains that the evidence concerning economic growth should be sufficiently strong in coming months to spur another three 25bp tightening moves, lifting the Fed funds target to 5.00% in the second quarter of the year. We think that growth will then be moderating sufficiently for the FOMC to cease tightening, even if core inflation drifts up mildly from its current levels.

    -- Joshua Shapiro, Maria Fiorini Ramirez Inc.

    * * *

    The Fed announced: "Core inflation has stayed relatively low in recent months and longer-term inflation expectations remain contained." Quite frankly, we do not believe them. We know that beyond the rises in food and energy prices, nearly everything -- from healthcare to building materials to education costs to insurance to commodities -- costs more. And gold, the world's best inflation indicator, is well over $500 per ounce. Where ever we look, we see evidence that prices have limited stability and an upward bias.

    -- Barry Ritholtz, Maxim Group

    * * *


    We do not see this statement as signaling that monetary policy is at neutral. The Fed continues to emphasize upside inflation risks and the potential need for further measured interest rate increases and we continue to look for three more rate hikes to take the funds rate to 5% by the middle of next year.

    -- John Ryding, Conrad DeQuadros, Elena Volovelsky, of Bear Stearns

    * * *

    We note that the Fed has begun to make explicit reference to "possible increases in resource utilization" -- Fedspeak for the declining unemployment rate -- as a driver of future core inflation, for the first time in this cycle. We think this is extremely important, because it signals that the labor market has now moved again to center-stage in the Fed's analysis and policy making process. The Fed is no longer dealing with shocks and their aftermath; the cycle is reasserting its primary role in determining policy.
    -- Ian Shepherdson, High Frequency Economics

    There was little news in this statement. The Fed continues to remain purposefully behind the inflation curve (willing to live with underlying commodity inflation as long as we see continued growth), trying to walk the tightrope of curtailing housing market speculation without squashing growth, hoping the powerful balance sheets of corporate America can offset any weakness from the consumer. Whether it can continue to play this tenuous game without causing a financial accident is still a big question, but thus far one has to say, "so far, so good," a phrase I would not have expected to now be uttering just a few short months ago.

    -- Chip Hanlon, Delta Global Advisors

    * * *

    The Fed stated that "some further measured policy firming is likely to be needed to keep the risks … balanced." With this change in language, the Fed is acknowledging that that stance of monetary policy can no longer be described as accommodative. Borrowing rates have moved up sharply over the past year, credit spreads have increased, and the demand for consumer and mortgage credit has dropped sharply.

    -- Brian Bethune, Global Insight

    * * *

    The Fed eliminated the phase "monetary policy accommodation." However, this does not mean that the Committee does believe that monetary policy is now neutral or restrictive." In particular, the Fed also said that "possible increases in resource utilization ... have the potential to add to inflation pressure." This is a clear reference to their view that the economy is still growing more quickly than the economy's potential, which suggests that the funds rate remains below its "neutral" level and, thus, is still providing stimulus to the economy.

    -- Steven Wood, Insight Economics

    * * *

    As expected, the dollar is falling across the board. We did indicate that any change in the statement should be dollar negative as was the case after the release of the Nov 22 minutes. Carry-trade enthusiasts are eyeing any change in signals from the Fed that would add some finality to the accumulation of the dollar's yield luster.

    -- Ashraf Laidi, MG Financial Group

    * * *

    Keeping a "measured pace" for so long heightened the possibility of the committee painting themselves into a corner. This language gives them a way out while still maintaining the ability to press on with higher rates if inflation continues to pose a threat. It may take the market a couple days to sort it out, but at first glance, this language could work. I would still like to see it evolve, however.

    -- William Polley, Western Illinois University

    * * *

    By changing the language as they have, the Fed is signaling that further rate increases are very likely, but not certain. Strong growth and inflation worries showing up in incoming data will continue to bring about further tightening, but any signal that growth is abating or that inflation is firmly under control will give the Fed reason to pause and reconsider whether further increases are warranted. … It will be interesting to see to what degree FedSpeak is used to set expectations as data arrive.

    -- Mark Thoma, University of Oregon

    * * *

    Economists React
    WSJ, December 13, 2005 3:28 p.m.

    Tuesday, December 13, 2005 | Permalink | Comments (3) | TrackBack (1)



    THE FED'S STATEMENTS reflect how the members of the central bank's Federal Open Market Committee perceive the economy. Their words have world-wide impact and the slightest changes are scrutinized for clues about where interest rates may be headed.

    The Dec. 13 statement announced that the Fed was raising its key short-term interest rate by one-quarter point to 4.25%, its 13th increase in a row, amid steady economic growth and relatively low core inflation. But the Fed signaled that it is less certain on its future rate actions than it has been in more than a year. Below is a look at differences between the December statement and the November one.

    click for larger graphic


    Graphic courtesy of WSJ

    No 'Accommodation'
    WSJ, Dec. 13, 2005

    Tuesday, December 13, 2005 | Permalink | Comments (1) | TrackBack (0)

    What Data is the Fed Watching?

    It is a fait accompli that today’s Fed meeting will raise rates a quarter point. The more important question is “How many more increases are we likely to see in the New Year?” In order to determine that, we need to know a few things: Why the Fed is raising rates, what their goal is, and what data they are watching.

    If we take the Fed’s own comments at face value, we can eliminate “popping a Real Estate bubble” as the goal. Fed Chair Greenspan has repeatedly claimed that it is all but impossible to identify a bubble in real time, and besides, it is easier to clean one up afterwards than to prevent one. While each of these premises may be (arguably) false, that is what the Fed is on record as saying. Therefore, believing their words, we must accept that targeting the frothy Real Estate Market is not the Fed’s primary goal.

    Eliminating the bubble rationale leaves 2 key issues: Price Stability, and Wages & Employment. As its been long apparent to everyone ‘cept most Wall Street economists, Inflation has been robust, due to commodity demand. That’s reflected in the actual price data of nearly everything (except income). Fools be warned: we reiterate our belief that the “Core Rate” is the greatest sucker play in all of economic data.

    That leaves Wage Pressure and Employment as the other key issue. And as noted, Wage pressure is nonexistent. Real income has been negative for most of the year. That’s not the reason the Fed is tightening monetary policy.

    Nor is job creation a basis for reducing accommodation. Despite rumors to the contrary, this has been an extremely poor job creation cycle, post-recession. There’s much less to the 4.4 million new jobs touted by Treasury Sec’y Snow than meets the eye. That’s a peak to trough number; measured from either the end of the recession or the start of the President’s 1st term, we get a 1.8 million number. Even the 4.4m number contains about 37% projected birth/death adjustments - an unusually high amount of the total. And we have seen an unusually large number of jobs created by Uncle Sam, rather than the private sector. Beyond the mere numbers, we see the quality of jobs created is much worse than the jobs previously lost, paying lower wages and less benefits.

    While the Employment data is generally discouraging, the good news is the abysmal job growth leaves the Fed with options. There is utterly nothing in the income or employment data forcing the Fed to keep tightening. It remains a story of inflation, and nothing else.

    We have never felt it is the responsibility of Wall Street Economists or Strategists to “advise” the Fed as to what to do; instead, we feel it is more advantageous to analyze their actions and what they may be basing them upon.

    Tuesday, December 13, 2005 | Permalink | Comments (4) | TrackBack (1)

    The “greatest irony” is that he is called the Maestro

    PIMCO's Paul McCulley lays out a surprisingly stark bitchslapping smackdown on Easy Al Greenspan. First, he quotes the Maestro:

    "In perhaps what must be the greatest irony of economic policymaking, success at stabilization carries its own risks. Monetary policy–in fact, all economic policy–to the extent that it is successful over a prolonged period, will reduce economic variability and, hence, perceived credit risk and interest rate term premiums."

    This quote is actually one of a series of statements from the departing Fed Chair essentially claiming that we get Bubbles because Greenie did his job so damned well.

    McCulley is having none of this; He deftly uses Al's own words against him:

    "Ah, “the eventual exhaustion of the forces of boom!” Roll enough games without a fingertip ball and you don’t have to worry about overhooking it, as your arm ain’t got the strength. But you do have to worry about underhooking it into the gutter. For, if (1) the “greatest irony” of successful Fed-driven macroeconomic stabilization – notably achieving secular “price stability” – is excessive reduction of risk premiums, otherwise known as bubbles, and if (2) the only strategy available for addressing such bubbles is to wait for their “eventual exhaustion,” then (3) the “greatest irony” is not as Mr. Greenspan declares, but rather that he is called the Maestro."

    As if that wasn't enough, McCulley notes that new Fed Chair Ben Bernanke does not see "the wisdom of relying exclusively on the hands-off-then-mop-up strategy" of Bubble management. Indeed, Helicopter Ben has already stated:

    "When this moral hazard is present, credit flows rapidly into inelastically supplied assets, such as real estate. Rapid appreciation is the result, until the inevitable albeit belated regulatory crackdown stops the flow of credit and leads to an asset-price crash. Bubbles of this type may be identifiable to some extent after they have begun, but the right policy is to do the financial deregulation correctly – that is, in a way that does not allow speculative misuse of the safety net – in the first place. Or failing that, to intervene and fix the problem when it is recognized.”

    One suspects that McCulley -- Managing Director of the largest Bond Fund company in the world --  approves of Bernanke as Fed Chair . . . 


    Reflexive Disintermediation: Say What? Learning To Live With It (pdf)
    Paul McCulley
    PIMco, Fed Focus| November 2005

    Wednesday, November 30, 2005 | Permalink | Comments (21) | TrackBack (0)

    Fed Spurs on Year End Rally

    The market’s technical picture has continued to improve. Rallies have been on decent breadth and improving volume. The Bullish Sentiment percentage is now over 50% - high, but not excessively so. Seasonal factors have also arrived just in time, as year-end contributions to tax deferred accounts have seen healthy inflows. Fund managers eventually put this cash to work as equity buys.

    The biggest negative factor now seems to be overseas capital flows have been at records recently. These buyers have, in the past, been reliable contrary indicators.

    But the newest factor supporting the year-end rally may be the Federal Reserve: While they made their obligatory Hawkish Inflation comments (“Upside inflation risks are the key concern”), the most recent minutes reveal quite a few elements that are intriguing. There seems to be a variety of Fed voices straining to be heard. Will Fed Chair-elect Bernanke inherit a uniform Fed, as Greenspan enjoyed? Or, when he takes of the central bank on January 31st, will there be some dissension in the ranks?

    Regardless, the Fed Minutes had some bullish implications:

    · Future Policy 'Increasingly Sensitive' To New Data;

    · Outlook Statement Must Change 'Before Long';

    · Some Members Warn Of 'Going Too Far' In Tightening;

    · US Econ Growth At 'Solid Pace' Despite Hurricanes;

    · Gov’t Spending To Boost Econ Growth Near-Term;

    (Source: Dow Jones)

    Whether this was just so much pre-holiday jawboning, or a signal of a significant change in direction, these comments are most definitely of interest to traders.

    Also worth noting: The coordinated approach of other central bankers: Japan’s Prime Minister has been pressuring the BOJ to hold off on tightening monetary conditions. At the same time, European Central Bank Governor Jean-Claude Trichet has apparently backed off his prior implied series of rate hikes. Implied is Euroland monetary policy may be a “One and Done” approach. This was echoed by ECB governing council member Guy Quaden: “What we have to do is to take our foot somewhat off the accelerator pedal. The question is not, for the time being, to step down on the brake pedal.”

    It appears that Central Bankers are coordinating their approach to global econ-management.

    The question for Fed watchers is how Greenspan might set up the Fed for his successor. He could hold off hiking rates in January, giving Bernanke a chance to show his inflation fighting chops? Or, will he allow the new Fed Chief to skip a hike in the March ‘06 meeting, based upon an inflation target?

    There will be plenty of data between now and then.

    Wednesday, November 23, 2005 | Permalink | Comments (1) | TrackBack (0)

    Regional Fed Banks Publications, Research and Data

    The Federal Reserve staff of economists and researchers is supposedly there to serve the Fed Board of Governors; But they also have a rich readership of academics, Wall Streeters, and other econo-geeks.

    Indeed, there is a divide in opinions over the end of Fed M3 reporting. The Wall Streeters and Fund managers like the clean data series and would like to see it continue; Some academics would also like it to stay. The Fed itself seems to think its not all that important.

    I have my own favorite regional Fed pubs; One I never miss is Monetary Trends put out by Federal Reserve Bank of St. Louis; The charts in it are terrific.

    So as a follow up to our last Fed data post, here's a list of the 12 Regional Federal Reserve Banks and the links to each of their publications and data resource pages:

    Federal Reserve Bank of Boston

    · Boston Fed Publications

    Federal Reserve Bank of NY

    · Fed Bank NY Research Publications

    Federal Reserve Bank of Philadelphia

    · Philly Fed Research Publications

    Federal Reserve Bank of Cleveland

    · Cleveland Fed Publications 

    Federal Reserve Bank of Richmond

    · Richmond Fed Economic Research

    Federal Reserve Bank of Atlanta

    · Fed Bank Atlanta Publications

    Federal Reserve Bank of Chicago

    · Chicago Fed Economic Research & Data

    Federal Reserve Bank of St. Louis

    · St. Louis Fed Publications

    Federal Reserve Bank of Minneapolis

    · Minneapolis Fed Publications

    Federal Reserve Bank of Kansas City

    · Kansas City Fed Publications and Education Resources

    Federal Reserve Bank of Dallas

    · Dallas Fed Publications and Resources

    Federal Reserve Bank of San Francisco

    · San Fran Fed Economic Research & Data

    There is enough data here to keep you plenty busy for the next few months.

    If anyone has a particular publication you find to be particularly outstanding, by all means please let us know!

    Thursday, November 17, 2005 | Permalink | Comments (2) | TrackBack (0)

    Money Supply and the End of M3

    Alex, I’ll take esoteric economic indicators for $100: 

    Last week, the Federal Reserve System announced that, as of March 23, 2006, they will be ceasing the publication of the M3 monetary aggregate. According to a Fed spokesman, the Federal Reserve Board of Governors wants to “de-emphasize the role of M3.” Academically, they add, this measure of money supply receives less attention than M1 and M2 do. A Fed spokesman also suggested that M3 is “no longer closely tracked by policymakers.”

    For those of you who are not econogeeks, M3* is the broadest measure of money supply in the U.S.

    The Fed will still report the individual components, and so anyone who wants to can (painstakingly) reassemble this into their own M3 No word if the regional Fed banks like the St. Louis Fed will continue to do so.

    One would hardly think an obscure economic measure is the stuff of conspiracy theorists. Some within the blogosphere are curious, but its hardly buzzing much over the issue.

    The cessation of M3 data publication was hardly auspiciously timed. Consider the huge increase in Money Supply over the past 8 years, while the US has becomie excessively reliant on overseas credit to fund our twin deficits (Balance of Trade, and Federal Budget) have reached record levels. So why stop reporting M3?

    Spencer England of SEER noted that MZM may be a more useful measure of Money Supply, ever since the relationship between M1 + M3 and the markets broke down. He blamed money market funds and banks paying interest on demand deposits as the prime cause for the decoupling.

    Oregon Economics Professor Mark Thoma noted that having M3 available makes it easier to track movements “into and out of M1 and M2 over time.” While not having it available “is not a huge loss, it was nice to know it was there to look at when it was needed. Thoma would have preferred that if M3 goes, “some improved measure of highly liquid assets beyond M2 be constructed to take its place.”

    Given the computing power at the Fed’s disposal, and the already incurred expense of compiling the data components, it essentially costs the Fed nothing to create the M3 data. Compared to CPI, this is one of the most steady data points the Federal Government generates. It seems a shame to lose a series that has been reported (and in such a consistent manner) for so many decades.


    * M3 includes M2 components, plus institutional money market mutual funds, large-denomination time deposits, repo agreements on U.S. government and federal agency securities, and Eurodollars held by U.S. addressees overseas.

    Monday, November 14, 2005 | Permalink | Comments (17) | TrackBack (1)

    Chart of the Week: M1, M2, M3 Money Supply Components

    While M2 appears to have grown the most over the past 3 decades, M3 is at presently the fastest growing aspect of Money Supply.


    M1, M2, M3 Money Supply Components


    Source: Mark Thoma, Economist's View


    Coincidentally or not, this is occurring as the twin deficits - US balance of Trade and the Federal Government budget deficits - have reached record levels.


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    Quote of the Day:

    “Big money is made in the stock market being on the right side of major moves. I don’t believe in swimming against the tide.” ~Martin Zweig

    Monday, November 14, 2005 | Permalink | Comments (3) | TrackBack (0)

    Historical M2 vs M3

    Does the more rapid growth of M3 over M2 signify anything ?

    M2 Money Stock (non seasonally adjusted)


    M3 Money Stock (non seasonally adjusted)M3_money_stock_1105

    See also:   Changes in M1, M2, and M3 over Time

    Monday, November 14, 2005 | Permalink | Comments (6) | TrackBack (0)

    The End of M3 Reporting?

    OK already!

    This is the unusual research (previously mentioned) under investigation:  The announced end of publication of the M3 monetary aggregate reporting.

    I already have a request in to the Fed about this, and I will be following up tomorrow. As soon as I have something concrete, I will update the Big Picture.

    I didn't want to discuss this until after I did more research, so as not to get all the Gold Bugs and Tin Foil hat crowd all worked up for what might be no good reason.  Now that the comments have let the cat out of the bag, there was no reason to sit on this any longer.

    By the way, there is no reason to look at seasonally adjusted data if your chart covers ALL the seasons -- as this multi-decade chart does.<space

    M3 Money Stock Spike
    click for larger chart

    Source:  Federal Reserve Bank of St. Louis


    Funny, without the adjustment, it looks even spikier! Pretty wild, huh?

    Here's what the Fed had to say about it:

    Discontinuance of M3

    On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate. The Board will also cease publishing the following components: large-denomination time deposits, repurchase agreements (RPs), and Eurodollars. The Board will continue to publish institutional money market mutual funds as a memorandum item in this release.

    Measures of large-denomination time deposits will continue to be published by the Board in the Flow of Funds Accounts (Z.1 release) on a quarterly basis and in the H.8 release on a weekly basis (for commercial banks).


    Oh, and credit where credit is due:  Hat Tip for first identifying this issue (if it actually turns out to be one) is shared by The Prudent Investor, Mike Runge and Will Thornton

    Sunday, November 13, 2005 | Permalink | Comments (14) | TrackBack (1)

    12 Federal Reserve Banks

    Some recent events have led me to do some unusual research on several Federal Reserve policies.

    Putting the research aside for the moment, I am continually amazed at how much great stuff is on the various Fed web pages. If you haven't played with the various Regional Fed bank sites, you are missing an astonishingly deep resource.

    Here's a few links to get you started:

    Federal Reserve Bank:

    Board of Governors of Federal Reserve

    and all their Public Speeches

    All About the Fed

    Regional Fed Bank (Map & Links)

    Individual Federal Reserve District:

    Federal Reserve Bank of Boston

    Boston Fed Publications

    Federal Reserve Bank of NY

    Fed Bank NY Research Publications

    Federal Reserve Bank of Philadelphia

    Philly Fed Research Publications

    Federal Reserve Bank of Cleveland

    Cleveland Fed Publications 

    Federal Reserve Bank of Richmond

    Richmond Fed Economic Research

    Federal Reserve Bank of Atlanta

    Fed Bank Atlanta Publications

    Federal Reserve Bank of Chicago

    Chicago Fed Economic Research & Data

    Federal Reserve Bank of St. Louis

    St. Louis Fed Publications

    Federal Reserve Bank of Minneapolis

    Minneapolis Fed Publications

    Federal Reserve Bank of Kansas City

    Kansas City Fed Publications and Education Resources

    Federal Reserve Bank of Dallas

    Dallas Fed Publications and Resources

    Federal Reserve Bank of San Francisco

    San Fran Fed Economic Research & Data

    That should be enough to get you started. 

    As you get deeper into each site, you will notice there is an astonishing depth and breadth of economic data at most of the various Fed Bank websites. Each Fed location seems to have developed their own emphasis, all have robust search features, lots of good data and analysis, and all sorts of great charts.  (I really need to get a hobby)

    Also, with this post, we rather belatedly introduce the category "Federal Reserve."

    Sunday, November 13, 2005 | Permalink | Comments (8) | TrackBack (0)

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