Putting the spice back into investing.

Postcards from Old Europe

Friday, April 30, 2004
The newest Postcard can be found at AngryBear's place! This week's installment looks at upcoming political events in Europe and the implications for structural reforms.
11:19 AM :: Karsten :: permalink ::


Yesterday saw the release of the US GDP data for the first quarter. This number does tend to excite economists and move markets so a closer look is warranted.

Most economists were expecting an increase of 5% - the data came in at 4.2%. Markets were weak on the back of the news and the dollar lost ground against the euro. What happened? The main reason growth fell short was the fact that consumer spending lagged expectations while the build-up of inventories continued at a slower pace than expected. The consumer data is pretty bad news. Everyone just knew that consumer spending would be very high because of the high tax refunds - so this number seems to have confirmed that the fiscal incentives didn't boost spending as much as everyone hoped.

Some of the slack was taken up by increased government activity (financed expanding the deficit) which will probably fade in the following quarters. As to whether high government spending is good or bad I refer you to Barry Ritholz.

Part of the data was grist for the mill of inflation hawks who are now replaying 1994 in their minds. The PCE index - which is closely watched by the Fed - was up by over 3% (2% core) - surely inflation must be just around the corner? Well, no. The year-on-year change is still at an acceptable level of 1.3%. Further gains in inflation will probably hike this to a y-oy change of around - say - 2% or so.

The Fed mihght be tempted to slam on the brakes - I just don't think that they will. GDP growth isn't as yet outpacing the trend growth rate and thereby reducing the slack in the economy. The labor market also isn't in a state of extreme growth - I stand by my prediction that the economy will lose momentum going forward and the rate hikes that are seen as "just around the corner" will take a while to materialize.
11:02 AM :: Karsten :: permalink ::

No news

Wednesday, April 28, 2004
Really - nothing much happend. We had good US consumer confidence numbers yesterday and middling Japanese data overnight. The consumer conf. data wasn't all that interesting as it didn't tell us anything that the labor market data didn't already imply. Consumers moderated their view of the future with the expectations part of the index sagging to around 94 from a high of over 105 in January. It just won't get much better than this - and they are probably right - it will be a great feat to just keep the economy powering along at the rate it is going right now.

New home sales are going strong but that isn't actually news. This is probably the last dance with regard to home sales as ever rising house prices and rising rates are now doing their utmost to price "normal" people out of the market in a rising number of areas.

Tomorrow sees some real data such as GDP growth and some labor market numbers. I'm on a client visit tomorrow so I don't know if I'll be able to blog.

Final thought: this dearth of real news gives me a great chance to focus on cleaning up my desk.

Cops, Robbers and the yuan...

Tuesday, April 27, 2004
US presidential hopeful John Kerry gave us this little gem yesterday:
I will launch a no-nonsense effort to stop the illegal currency manipulation that's going on in countries like China and Japan
Now why didn't I think of that! What Asia is doing is illegal! Isn't it obvious?

Buying the dollar and investing the cash in Treasuries thereby keeping rates down and imports cheap is a crime! All those SUV's that people are buying and all those shiny imported doodads are products of criminal activity. Hah! It is all an evil conspiracy by those shifty little Asians (who are probably muttering amongst themselves in their foreign language because they have been found out!). You used to have to go to unsavory parts of town and meet with a guy called Vito to buy this kind of stuff - now you can get hot goods at Walmart. This must be stopped!

Good thing that John Kerry is going to send the cops after them!
10:22 AM :: Karsten :: permalink ::

Back to blogging

Monday, April 26, 2004
The German ifo business-climate index rose unexpectedly giving European markets a further boost. A closer look shows that the improvement came from a strong showing with regard to current conditions - future prospects are still looking bleak with the expectations component of the index losing ground for the third straight month.

On other news: the Chinese President continued the government's efforts to dampen economic growth by warning about the negative impact of "blind investment". As I've said befor: China is still in many ways a command economy so we can be pretty sure that any order to slow down will eventually be complied with. This patently doesn't work with foreigners so they have to warned off in other ways. Chinese equities have been looking pretty weak - looks like the market is already discounting a coming slowdown.

The commodity trades have also been coming off the boil with prices sagging over the past couple of days. Seems as if some speculators are getting cold feet - and most positions are speculative right now.

Missing: Tax Refunds

Monday, April 19, 2004
Everyone knows that the larger than expected tax refunds have been boosting spending by enhancing consumer's individual cash flows. Is everyone right? Spending is certainly strong but the amount of refunds isn't as much as people might have expected. Even conservative economists were looking for increases in refunds of around 20 - 30%.

A quick look at the numbers shows us that refunds were up by 7.7% vs. last year. It would take some very late filings which lead to above-average refunds to really pump this number up into the high double digits.

So where are the refunds? One bogey is the alternative minimum tax (AMT) which has seen it's scope increase over the last couple of years to encompass ever more rich and semi-rich people. The AMT is - to put it very simply (and keep in mind that I'm one of those evil foreigners - so don't trust what I write) an alternative tax calculation method which excludes most deductions and works with a fixed exemption. The aim of the AMT is to prevent people pushing their income to zero by the use of creative deductions.

The only problem with the AMT is that some "normal" deductions are now forcing people into AMT-taxation - this is bad because the AMT uses higher tax rates for the purpose of calculating the tax owed. In short: someone taxed under AMT does not get the chance to profit from the 10, 15 and 25% tax brackets for (part) of their income. So what normal deductions are pushing people into AMT? I would suspect that mortgage interest deductions (rising because of higher mortgage payments on ever more expensive houses) and state taxes are the culprits. Many US States have been raising taxes to balance their budgets. As these taxes are deductible at the federal level, they could lead to the AMT kicking in. This would in turn lead to these people losing out refund-wise.

The lower than expected gain in disposable incomes via refunds could lead to decreased consumer spending going forward. This would put even more pressure on growth in disposable incomes - wages would have to rise and more people need to get to work.

The saying goes that every cloud has a silver lining. Does this have one as well? The good news in all this is that the government doesn't actually have the cash to give a refund anyway - any money returned to you would expand the deficit. So if refunds come in at a lower rate than expected, the government can point to reduced funding requirements and a lower deficit. So in the end everything balances.

I wish you a great week and am looking forward to seeing you on Friday.


I will be out of the country on business 'till Thursday evening. I'm headed off to Bucharest to visit a client so I won't be able to blog during that time.
12:32 PM :: Karsten :: permalink ::

Monday Roundup

Around 1 trillion yen of bad loans surfaced at UFJ bank over the weekend. The Nikkei was weaker on the back of this news while UFJ ended limit down. The Japanese bad loan saga just keeps reminding me of "Godzilla, Horror From The Deep". Just when everyone thinks that the monster has been defeated, it pops up in Tokyo Bay to wreak more havoc.

Weaker US economic data and softish Fed utterances gave rise to some dollar weakness - expect Greenspan's bouts of testimony on Tuesday and Wednesday to move the FX market. There isn't much other news out this week.

12:29 PM :: Karsten :: permalink ::

Postcard from Old Europe

Friday, April 16, 2004
Another Friday, another Postcard from Old Europe! Be sure to check out this week's installment of my weekly column which looks at the migration-aspect of EU enlargement.

Price confusion at CNN Money

Thursday, April 15, 2004
As I was commmenting on the results of the NY Fed's survey I started to read the CNN/Money piece. Something struck me as strange so I reread the thing. They write
The one concern for investors is that the information about rising prices, as 57 percent of respondents reported higher prices and virtually noe [sic] reported a decline.

The higher prices, while good for manufacturers' earnings, could prompt the Federal Reserve to raise interest rates that they've kept at historically low levels for more than a year.
Italics added by CurryBlog
Dear folks over at CNN/Money, I know this economy stuff is difficult but you really should take some time to read the original material! 57% of respondents said that prices paid were up - not prices received!

Now let's pull this together: The stuff I buy to make my widget is rising in price faster (prices paid) than the price I can charge my customer (prices received). Now why is this good for my earnings?

Should I care about the increased initial claims numbers?

No. These numbers are volatile and tend to jump around. As long as we don't see an uptrend in the 4-week average we should be safe.

In other news: The NY Fed's manufacturing survey came in at around 36 which was higher than most analysts had been expecting. The story told within the report is familiar by now - prices paid are rising while prices received are barely moving (so much for the strong correlation between rising commodity prices and CPI). The outlook is generally positive with the employment (incl. workweek) looking more positive than last month.

Link Tip

Wednesday, April 14, 2004
Barry Ritholz unearthed a great link to the American Association of Individual Investors' website which features a list of the 10 most important economic indicators. A great addition to the discussion going on at Angry Bear in the comments of this post about the predictive power of the consumer sentiment indices. The article not only explains why - say - Manufacturing and Trade Inventories and Sales are important, it also gives you a handy link to the source of the data.


The CPI data for March is out. The biggest number in the release was the rise in energy prices (+1.9%) which helped push the headline number to 0.5% in March. The core number came in slightly lower at 0.4%.

This works out to 1.7% (1.6% for core) over the last twelve months. Not roaring higher but still higher than most people expected. If you shine an X-ray on the numbers you'll see that housing, medical care, transportation and apparel were the big movers in the realm of the core numbers. The gain in the transportation number can be attributed to the gasoline price - from the report
A 5.5 percent increase in the index for gasoline accounted for over 95 percent of the advance in the overall transportation component.
Housing rose as well - though not primarily because of exploding costs for rents. The culprit was not the housing bubble, it was the Holiday Inn
The index for housing rose 0.3 percent in March. Shelter costs, which rose 0.1 percent in February, increased 0.6 percent in March, largely as a result of a 3.8 percent advance in the index for lodging away from home.
But what does it all mean? Well to me it means that the Fed might feel tempted to fiddle with their message but I don't see any immediate policy change. The rise in prices probably reflects companies efforts in passing on higher import prices and the return of a modicum of pricing power. I'm looking for the FOMC to present a balanced picture at their next meeting with a statement to the effect that "the risk of inflation is equal to the risk of deflation" - a change from their last bulletin
The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation. With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.
They can now drop the word "equal".

Why do I think that the Fed won't raise yet? Well, resource use is still slack and 1.7% inflation isn't that much (yet). The USD 64k question is: am I right in assuming that we'll see a slowdown in the US economy? If I am right, we'll see that price inflation remains low - if I'm not right, the Fed will have to raise by fall. Ahh, interesting times we live in.

Dark thoughts about the future

Tuesday, April 13, 2004
While many commentators seem to think that the strong jobs data we saw at the beginning of the month was the missing link that rounded off a picture of high future growth I'm not all that sure. I am still quite skeptical about the legs on this recovery and am still pretty sure that we're in the middle of a mini cycle which might burn itself out by the end of the year.

Wages are stagnant and consumers are relying on tax cuts and debt to finance their purchases. Investors have been finding that the advice "neither a borrower or lender be" is flawed. As capital has become cheaper it makes very much sense to pump more of it into the trade of your choice. In a world of low interest rates the carry trade is king - just take a look at all kinds of risky assets and the size of the positions held by traders vs. the historical average.

The interesting thing about the entire situation is that everyone knows that it can't go on forever. The only real question is how long the unsustainable will be in fact sustained. At some time in the future interest rates will go somewhere from where they are now. What they will do depends on who you ask. If you ask someone who is of the "the future's so bright I gotta wear shades" persuasion, you'll hear that rates will rise. This is of course bad news for anyone with any short-term debt as the cost of servicing said debt will rise.

If you think rates are going to go down, then - by definition - you have a problem on the asset price side of things. The double whammy would of course be rising rates and falling asset prices (can anyone say "housing market").

What about all those people up to their necks in commodities? Should they care? Everyone knows that China is sucking in everything they can get! The only problem is that the country is sucking through a progressively narrower straw! John Mauldin related this little tidbit:
At Beilun port near Shanghai, one of China's major iron ore import terminals, ships must wait for up to a month to berth and offload. China is expected to import 180 million tons of iron ore this year, up about 21% from last year. They need it for its steel, construction and auto industries.
This mad dash is pushing up inflation and leading to "irrational exuberance" with regard to capital investment. The Chinese government has latched on to this and has started a campaign of slowing down the economy.

Should we care? Well if one of the leaders of a command economy says things like
In his opening speech at the National People's Congress March 5, Prime Minister Wen Jiabao said his government wants to slow down the rate of "GDP-measured" growth, to 7% this year. In 2003, it was 9.1%. China is concerned not only about the risk of inflation, but also about too much unbalanced and "low level" investment, Wen Jiabao said. The focus on "GDP" had not succeeded in resolving the long-standing problems of China's economy, especially the disparity between the rapidly growing eastern coast, and the vast interior. These disparities are growing, and this is a big risk for China's welfare.
Sourced from here
Any slowdown in consumption of commodities would wreak havoc amongst at least some of those holding speculative long commodity positions.

In the meantime we should keep in mind that rising commodity prices (ex oil) have exerted no significant inflationary pressure on consumer prices in the past. What rising prices for inputs do is shred manufacturers profit margins.

While markets are still robust they are banking on everything panning out - the US economy will expand further and thereby create new jobs, China will continue powering ahead, rates will stay low. If only one of these critical supports fails, we could be looking at a reappraisal of current market valuations.
12:42 PM :: Karsten :: permalink ::

Easter Break is over...

... and I finally have some time left to blog. The latest news has confirmed the uptrend in the near term economic outlook. The Japanese market was again strong and managed to close at levels not seen for three years. The news flow coming out of the county is still looking good - the latest number I saw was that machinery orders rose 4.9% in February partly reversing a decline in January.

European markets are up across the board while the dollar is showing strength ahead of today's data. The currency market seems to believe that retail sales for March will be strong. A quick look at the blogosphere gives anecdotal evidence that this might be the case - maybe we could compile an index of economic activites by scanning blogs for "I bought" and variants hereof? Anyone?
11:33 AM :: Karsten :: permalink ::

Easter Update

Friday, April 09, 2004
No blogging over the next couple of days. The Easter weekend is coming up and I'm heading out of town as Friday (today) and Monday are holidays here. In the meantime you could go over to Angry Bear to read my newest post. My Postcards from Old Europe column appears there every Friday.

If you need more insightful and interesting stuff just go visit one of the fine sites in my blogroll to your right. Free tip: visit Dan's site. his new addition to the blogroll provides you with - pardon me Dan - something akin to the weekend supplement of your newspaper.

Initial Claims...

Thursday, April 08, 2004
... for unemployment insurance benefits were lower again this week. The 4-week average moderated to 336k confirming the downward trend that has been in place for a while now. Continuing claims were down as well - this being a combination of less people entering the ranks of the unemployed and other people dropping out via benefits running out. These numbers to not presage a bull market in jobs or stocks - although seeing strength in any kind of employment data is always very positive. Keep in mind that employment is a lagging - or at best - coincident indicator. These numbers tell us more about where we are or where we were, not where we are going.

Alive and kicking

If you can manage to push your way through the anti-globalization protesters to the WTO website, you can download interesting information on world trade.

I'd like to flag up some facts that I found to be interesting. World trade rose at a quicker pace than world output. Asian economies had the
most dynamic trade performance. Their merchandise exports and imports expanded in real terms (i.e. adjusted for price changes) between 10 per cent and 12 per cent, more than twice as fast as world merchandise trade.
China saw imports and exports rise with imports rising faster than exports!

China does not just spew out finished goods by creating them from thin air - people are making money selling things such as basic materials and consumer goods to the Chinese. Shouldn't strategy therefore consist of trying to make stuff the emerging class of (somewhat) wealthy urban Chinese would buy vs. trying to stop local customers from profiting via lower prices on imports? Trade restrictions are not free - someone will pay - and that someone is likely to be a person who will really feel the bite of higher prices at his or her local supermarket.

In unrelated news: we found that nobody in the office knew what the day before Good Friday is actually called in English. A quick Google turned up "Maundy Thursday". What would we do without the internet!
12:37 PM :: Karsten :: permalink ::

No real news

Wednesday, April 07, 2004
Nothing much to write about - Nokia got slaughtered yesterday on the back of a profit warning couched in some very unclear language. I sold a couple of put options to profit from the increase in volatility - the trade has been holding up pretty well so far.

In other news: Bundesbank head Welteke is under pressure to resign (which he probably will) after letting a local bank pay for his stay at nice hotel across the street from where I work. Conspiracy theorists will connect the dots and find that the allegations cropped up just after the German and Dutch board members allegedly vetoed an interest rate cut by the ECB last week ("Ve haf vays off making you cut!").

No real data flow on the agenda today so I'll probably see you all again tomorrow.

Morning roundup

Tuesday, April 06, 2004
The Nikkei finally managed to close above the 12,000 level giving us momentum players who have been piling into the Japanese market a warm fuzzy feeling. The Japanese leading indicator came in at around 77 which is above the 50 watershed level which signifies an ongoing economic expansion. The yen was pretty strong although market rumor has it that there might have been some intervention to weaken the yen near the end of the asian session.

The US continued providing us with strong data. The ISM services index was up by 5 points (came in at 65.8) with analysts expecting a slight fall. The bond market did the predictable thing and ambled lower.

German unemployment came lower - the problem was that it didn't come in as low as people were expecting. The spring usually sees a seasonal pickup in employment and analysts were looking for a stronger jobs gain than the one we saw. After seasonal adjustment a total of 44k people joined the ranks of the unemployed.

Not that anyone should be all that concerned - there wasn't really any reason to expect a large gain in the employment figures. Employment is considered a lagging indicator so that we should expect to see higher employment following on the heels of economic growth. As there was almost no economic growth in Germany, we shouldn't expect gains in employment. No smoke, no fire!

Remember to keep in mind that the smoke/fire thing doesn't work the other way around. Gains in employment do not always mean that the economy will be strong going forward. Large gains in employment only signify that companies have reached the end of the rope with regard to immediate productivity gains and are therefore taking on warm bodies. Think of it in Scotty-Terms:
"We've just entered the high sales zone, Captain."

"Captain, she canna take it much more. Another ramp in production and the engines'll
burn up fer sure."

"Scotty, we haven't even started yet. Inventories are low, we have to get goods to market!"

"Sulu, plot a course to the hiring quadrant."
So the decision to hire is based partly on current or past conditions with a dash of crystal ball gazing added in. More jobs do not automatically equate to a further shot in the arm to the economy. I would be more optimistic if the recent past had been characterized by low consumption and high saving. An ensuing boom in hiring could then have lead to more spending and thus better prospects for the current cycle.

This has not been the case - consumers have been spending regardless of the fact that no jobs were being added to the economy so I don't see any pent-up demand being released in the near term.
11:09 AM :: Karsten :: permalink ::

Another look at the payroll numbers

Monday, April 05, 2004
I hope that all my readers had a nice and relaxing weekend. I spent Saturday out shopping with my girlfriend, which meant standing outside diverse changing rooms for hours on end saying "that looks great" in different variations. On the way back we saw some of the 250k protesters who were mobilised by their respective unions. My first thought was that the owners of the bus-companies who brought all these people to Berlin must be hoping that this is just the first wave of demonstrations.

I took some time yesterday to look at Friday's USEmployment Situation Summary. What struck me was the fact that while the headline number was strong the rest of the report was pretty lackluster. The average workweek actually fell while hourly earnings rose at a very modest rate. Manufacturing stopped losing jobs for the first time in almost 4 years. Construction was one of the main contributors to jobs growth adding 71k jobs to the total. The return of the striking supermarket workers in California didn't really push numbers higher - the report said:
Within retail trade, employment in food stores increased by 13,000 over the month, reflecting the net impact of workers returning from a strike.
Although the bond market seems to think that a rate cut is now definitely on the cards I have to admit that I'm not so sure that the Fed will actually tighten this year. I'd like to see some more strength in wages and a rise in consumer prices before I'll start to believe that the FOMC will hike rates.

A final thought: much has been made of the divergence between household and establishment survey. I share the view that payrolls tell the "truer" story - the reason why can be found in this post by Barry Ritholz.
10:24 AM :: Karsten :: permalink ::

Jobs data

Friday, April 02, 2004
...came in way ahead of expectations. 308k new jobs were created in March which is good news. This number is akin to a champagne cork finally popping out of the bottle with a loud bang. The bang was especially loud over in bond-land. The German Bund-Future dropped over 100 basis points in an instant while the five- and ten year gained massive amounts of yield in an instant - whoever says that bonds are dull doesn't know what he's saying. Interesting shift in the yield curve!

The market seems to think that a Fed rate hike is becoming a very real possibility - Fed Funds futures are showing higher implied yields. If you look at the data traders are convinced that we'll see a rate hike in September or August. I'll look through the data on the weekend and try to do some real analysis on Monday.

The only thing that I'm pretty sure about is that the sitting US President is arguably one of the happiest campers around after this data. If the economy manages to continue creating jobs at a 150 - 200k level prospects for reelection will improve day by day. Full disclosure: I do have to admit that the contender and I have something in common - we both went to swiss boarding schools.


The newest instalment of my Postcards from Old Europe is up at Angry Bear's blog. Go there!
11:39 AM :: Karsten :: permalink ::

Expectations creep

I've been watching the consensus estimate of payroll data slowly creep upwards this week. Reuters has the consensus at 103k new jobs while Bloomberg's poll came in at 120k. Briefing.com conducted a poll as well and came up with a consensus of 123k.

The consensus of the professional's consensus comes in at around 120k (median). I just spent five minutes on the phone asking some colleagues what they were expecting - here goes:
Our consensus comes in at 111k. As a control I called one of our secretaries, a receptionist, and two other non-investment professionals. They said:
Their consensus is 114k. So, the race is on. May the best forecaster win!

Update: Our secretary won! She came in first with a winning forecast of 198k!
11:37 AM :: Karsten :: permalink ::