Putting the spice back into investing.

Singalong Time

Tuesday, August 31, 2004
This week brings the return of the CurryBlog Singalong - this week's tune is ideally suited to be played whilst reading about the record low in the US personal savings rate. Alright, a one, a two, a one, two, three, four:
Sung to the tune of Subhuman by Garbage

Draw down all your savings, destroy your future
Create a scene
There goes all your reason, it's helter skelter
It's not a dream
Come back from the mall, remove your blindfold
What do you see?
Nothing left to do here, there's nothing new here
It's all the same
You're going down, down, down, how low can you go?
You're going down, down, down, how low can you go?
You're going down, down, down, how low can you go?

There, I feel better now.

Income? What income?

The US consumer is one of the modern wonders of the world. The consumer's mantra must be
"neither rain, nor snow, nor sleet, shall keep me from shopping"
It seems as if no amount of hardship can keep people away from the shopping mall. The thing that keeps astounding frugal old me is that John Q. Public keeps growing his spending quicker than his income. The relevant data on Personal Income and Outlays came out yesterday and it tells us that
Personal income increased $11.0 billion, or 0.1 percent, and disposable personal income (DPI) increased $7.9 billion, or 0.1 percent, in July, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $65.6 billion, or 0.8 percent.
This should help support GDP growth going forward - albeit at the price of rising indebtedness and a miniscule savings rate.

Speaking of which: the savings rate is now at a level where you need a microscope to see the number - the BEA says:
Personal saving as a percentage of disposable personal income was 0.6 percent in July, compared with 1.3 percent in June.
This low level of savings borders on the ridiculous - I mean what do people think? Is the market going to do their saving for them? Or is social security going to be enough to live off of in old age?

Negative terms of trade shock

Monday, August 30, 2004
Wow, you're still reading after that headline! Congratulations, as a reward you may follow this link where Pimco's Paul McCulley explains what the current high oil prices might do to the economy. This little piece is an excellent example of how to get economic thoughts across to - well - anyone! I highly recommend it. Some excerpts follow:
Less technically, it's [oil price hike] similar to being told by your father-in-law that in honor of your mother-in-law's outrageously good scalloped potatoes at Thanksgiving, you will be expected to bring two bottles of fine wine this year, not one as you did last year. The price of those spuds just doubled. And you gotta have them!
Returning to the saga of the second bottle of wine you delivered to your pops-in-law, does he put it in his cellar, or do you insist on drinking it at Thanksgiving dinner? If he puts it in his cellar, then there has been a one-time shift in wealth from you to him. If you had planned to drink it before giving it to him, and are budget constrained, then there has also been a one-time downward adjustment in your consumption, a one-time blip upward in the economy-wide savings rate, a one-time upward adjustment in economy-wide inventories and, presumably, a one-time downward adjustment in the wine producers' output, since your budget constraint prevents you from replacing the wine that you would have drunk but didn't, because it is now in pops-in-law's cellar.

A fresh start to the week

The end of last week saw the release of the revised GDP data for the second quarter. I was pretty pessimistic ahead of the data as I was afraid that the huge trade deficit would negatively impact the number. The impact was there all right - the deficit subtracted around 1.3% from growth!

The good news is that businesses and consumers stepped right up and did the right thing - they kept spending. Domestic spending came in at +1% which was almost enough to cancel out the negative impact of the trade deficit.

The screeching noise you hear when you're reading the report is the slowdown in corporate profits. Corporate profits were flat vs. Q1 coming in at + 0.1%. To be fair we should say that we're still looking at "good" numbers - the simple fact to keep in mind is that the numbers are just not as good as they were in Q1 (and investors ignore slowing profit momentum at their peril!).

In all it looks as if the cycle is doing its thing - we should see momentum moderating as the year progresses with the GDP numbers coming in at around the 3% level in Q3 and the heading down to a 2-point-something in Q4.

This week activity is focused on the mother of all numbers (Friday's payroll survey). I keep hearing 150k new jobs being bandied about - let's see what happens.


Friday, August 27, 2004
It's GDP day today in the US and expectations have been creeping ever lower. The negative trade deficit data should negatively impact the number. If you consider the positive data such as construction spending you should be looking for a revision of Q2 growth to somewhere around 2.4 to 2.7 from 3%.
11:07 AM :: Karsten :: permalink ::

TAPPI - the place to be!

Wednesday, August 25, 2004
Do you catch yourself thinking "I should really be in the decorative laminates business?" If you don't you might think twice now that senior Fed officials use the annual "TAPPI Decorative and Industrial Laminates Symposium" as a forum to present their views.

No, I'm not kidding. Atlanta Fed President Guynn spoke at said symposium and mostly reiterated standard Fed verbiage. Guynn even asked the 64k question:
"In light of recent reports, I would concede that it's fair to question what's ahead. You might ask if the economy is getting bogged down for an extended stretch of eroding growth. Or are we just going through another brief soft patch on our way to sustainable recovery?"
Now what do you think the answer was? Yes - the "soft patch theory" is still intact. The answer to the question posed above is
As a result, Guynn felt the pause would prove fleeting and the "likelihood of solid and sustainable growth looks good". But he stressed the Fed was not ignoring events.
Nice to know that the folks at the monetary helm are not asleep. No way Jose! Now the only problem is that reality keeps intruding on the Fed's view of the world. And yes, even the Fed can be surprised by events
"It's important to keep in mind that we can all be surprised by output and price developments as they unfold..."
True. I hope that these surprises don't keep piling up in a negative way. I don't really want to imagine what kind of policy response a future would bring in which (oil) prices keep rising while growth keeps getting softer and softer.

Last thought: I'm pretty sure that you all thought that the Fed was hiking rates because growth is robust. Well think again. The Fed is mostly hiking because rates were low. Huh? Survey Article said:
Guynn stressed the Fed was not raising rates because it felt the economy was growing too fast, but rather because with interest rates so low, an accommodative policy was not appropriate amid a widening economic expansion.

Ok - I'm pretty sure that I've convinced you to get into the laminates business - where else can you get Fed speak with your lunch? For more information visit TAPPI!

Endnote: Why does my spell checker want to change "Guynn" to "Guano"?

Emerging Markets

Tuesday, August 24, 2004
I just came across a Reuters article with a headline that screams "Emerging mkts attractive via ETFs -Morgan Stanley". Now I don't know if emerging markets are really that attractive but I do suspect that ETFs are not really the best investment vehicle you can use to increase you exposure to these markets.

ETFs or Exchange Traded Funds are mutual funds which usually track indices and which can be traded just like stocks. They have a pretty low expense ratio because they are not actively managed. The article says:
"Exchange Traded Funds, which are traded like equities, but track an index without the investor having to buy all an index's components, increasingly offer a simple and cheap way for investors to get an exposure to sometimes challenging emerging markets, Deborah Fuhr, ETF strategist at Morgan Stanley said."
Well yes, but the problem here is that indices in emerging markets are not the thing I would really want to invest in. Why? Well, there are a lot of countries in which the index is dominated by two or three companies - South Korea comes to mind here. If I'm not totally mistaken then the three top companies there account for 25% of the market - so why buy the index if you're only getting Samsung, SK Telekom and Posco?

Indices in Emerging Markets tend to be highly concentrated and usually consist of just a couple of sectors (Energy, Banking, Telecoms and IT come to mind). That is why I believe that such markets are really more suited to an active investment strategy. ETFs seem to me to be a hassle-free kind of ways to invest in developed markets - not in markets where a fund manager might actually add value.

For discussion: why might Morgan Stanley think that ETFs are a great idea?

Side note: My favorite definition of emerging markets: "Emerging markets are markets that are difficult to emerge from in an emergency"


It is Harry Markowitz's birthday today. Congratulations!

Locusts and Tourists

Monday, August 23, 2004
I was watching the news on the weekend and saw a feature on the horrible locust plague that has been ravishing northwest Africa. This bit of news reminded me of something I saw at about this time last year in a wholly different location.

I was on holiday on the Greek Island of Mykonos with my wife last year. Mykonos town is a very scenic little place with a pretty relaxed feeling about it during the off season. While we were idly sipping a frappe we noticed that the activity level around us started rising.

Shopkeepers opened up boarded-up shops, street "artists" went back to their warehouses to stock up on folk art and waiters went into that kind of trance which usually signifies that an onslaught of guests is imminent.

While we were wondering what was going on the invasion took place. The little streets of Mykonos town were thronged by masses of people that a cruise ship had disgorged down at the harbor. The passengers exhibited symptoms of serious shopping-withdrawal and stared buying anything in sight. It was an incredible sight that was only matched by looking at a swarm of locusts devastate a grain field.

The entire episode lasted for about two hours. After that blissful calm settled back on the island. Before anyone gets bothered: I do recognize that we are talking about a wholly different situation with regard to the impact on the local population.
10:19 AM :: Karsten :: permalink ::


Friday, August 20, 2004
Most of the work issues that have been impeding my blogging are resolved so I've finally found the time to return to posting my weekly "Postcards from Old Europe" column over at Angry Bear's place. This week's installment looks at the effects that continuing high oil prices might have on the US economy.

Conventional wisdom has it that the oil price is in a bubble-like phase. Therefore any reduction in geopolitical uncertainty (now how likely is that) should lead to a rapid fall in prices. I'm pretty sure that price gains are being exacerbated by investors who are buying into the oil market to hedge themselves against any further price hikes (thereby bidding up the price today) and by speculative longs.

I suspect that the reason that oil prices are so high is that oil prices were so low in the past. Companies didn't have much of an incentive to explore for new capacity at sub $20/barrel prices. The market will now work its magic and ensure that more capacity will become available in the future. The problem is that this will take time. Anyway, high oil prices are not what the world economy needs right now - with the recovery coming off the boil in the US and a very fragile expansion in Europe we don't really need higher energy prices.
11:59 AM :: Karsten :: permalink ::

One down...

Thursday, August 19, 2004
...one to go. The Index of Leading Economic Indicators was down 0.3% in July. The index is compiled by the Conference Board and is made up of 10 separate gauges. Four of these were up with the rest coming in softer. This is the second month that the index came in weaker. Conventional wisdom has it that three declines in a row signify danger (well OK, not really danger but a more moderate rate of economic growth) ahead.

Looks like Google finally managed to crawl to market with the first price somewhere around 100 USD. A look at the screen tells me that the Philly Fed index is out at an underwhelming 28.5 which is very much below the consensus estimate. Market reaction seems muted - I don't think that anybody was really all that surprised by this weak showing.

No News is, well, no news.

No major data releases yesterday to write about. The focus is firmly on today's numbers with the Philly Fed being the most important. After the lower than expected NY Fed survey economists have been busy revising their estimates downwards. Leading indicators and initial jobless claims are out as well today so we shouldn't complain about the lack of economic input.

Nothing much else happened - oil is still expensive, Iraq is still violent and the Olympics are moving along. More later.
10:34 AM :: Karsten :: permalink ::


Tuesday, August 17, 2004
Remember the good old days of several months past? The Fed was thought to be woefully behind the curve with regard to inflation and everyone just knew that rates had to go up. And of course the CPI was a sham - especially core CPI - who can live without food and energy after all?

Now we learn that headline prices actually fell in July - imagine that. Lower gasoline prices did the trick. The much maligned core number was up by a whisker with some categories such as cars showing price declines. This nicely shows what the Fed means by price hikes being "transitory" - not that I expect the return of disinflation. Core CPI should continue to expand throughout the rest of the year with Inflation leveling out at around 2%.

This in turn means that I firmly expect one more rate hike next month to 1.75%. What happens then is very much a function of tomorrow's data. What do you think?

News? What news?

The NY Fed survey came in way below expectations yesterday. Economists were expecting a number around 30 and we got a 12.6 which equates to a drop of 23 points. My mantra that the expansion is losing momentum was again underlined by weak new orders and shipments data. The positive news was that the employment index was up. The only problem with this is that it is a result of ever more companies saying that they are not going to cut jobs - the mechanics of a diffusion index turn this stagnation into a positive.

Nobody really seemed to care about this number - the inundation by bad news has probably numbed market participants to such an extent that this data point didn't have any real effekt on sentiment.

Today will see the release of many analysts favorite bugbear, the CPI. I think that we will see a very modest gain in this number - nothing to raise the spectre of rampant inflation.
10:02 AM :: Karsten :: permalink ::

Confused about P/E ratios?

Monday, August 16, 2004
Don't you love watching talking heads ruminate about how the market is valued? There is a virtual guarantee that someone will cite price earnings ratios to demonstrate that the market is cheap (or expensive or just right).

The reason why this number can be used to justify almost any standpoint is nicely presented in this article which draws upon work by Cliff Asness. The problem is of course not in the price part of the the P/E but in the earnings bit.
One widely used definition relies on analysts' projections of what companies will earn over the coming year, while another focuses on what companies actually earned over the previous four quarters.
So we can either use real earnings of lala-land earnings. Then we just have to mix and match numbers (reported/estimated, today/yesterday, ...) until we get the result we are looking for. Or as the article puts it
Consider the statement, often repeated these days on Wall Street and in investment newsletters, that the market's current P/E ratio is not abnormally high. The argument, as Mr. Asness hears it from fellow money managers, goes like this: "Currently the S.& P. 500's price-to-earnings ratio is in the mid-teens. Comparing that to an historical average of about 15 shows the market to not be more expensive than average."

But that argument relies crucially on a "sleight of hand," Mr. Asness says. The market's current ratio is in the mid-teens only if it is calculated by using projected operating earnings. Yet the long-term average ratio is as high as 15 only if it is calculated by using trailing reported earnings. It is bogus to compare the two figures.

11:51 AM :: Karsten :: permalink ::

Decomposing Fed Speak

HSBC economist Stephen King (no, he doesn't write scary novels on the side) does a great job of dissecting the recent Fed statement. He contends that it is a mixture of fact, assertion and faith. Let me reproduce his key points here:
"...Output growth has moderated..." That's a fact.
"This softness likely owes importantly to the substantial rise in energy prices." We are now moving into the world of assertion.
"The economy nevertheless appears poised to resume a stronger pace of expansion going forward." This third strand of the statement is no more than an expression of faith, but it's been thrown into the mix partly to justify the Fed's overall desire to get short-term interest rates back to something approaching "neutrality". But if energy prices have been so important in explaining the recent softness of activity, why should it be that the economy will expand more strongly? After all, oil prices have risen further since June and July, so if oil prices are to blame, it seems more likely that the data for August and September will be weaker than we have seen over the past two months.
Quite. Now go and read the whole thing.
11:39 AM :: Karsten :: permalink ::

As the World Turns

Watching capital markets is like a race with no finish line. Analysts chase after every data point and then quickly their sights on another economic figment as soon as the first one comes over the wire.

This week the investing class will focus on a series of US activity gauges such as today's New York Fed survey and the Philly Fed survey on Thursday. Last week ended with that serial shocker, the trade deficit.

From the statement:
The Nation’s international deficit in goods and services increased to $55.8 billion in June, from $46.9 billion (revised) in May, as exports decreased and imports increased.
Imports are gaing in sectors which were thought to be very robust. Take the rise in imports of computers. This would seem to indicate that production is shifting ever more to the Pacific Rim - no wonder that US tech firms are looking soggy in the equity markets.

In all the high trade deficit could take some of the shine off of future (and past via revisions) GDP growth numbers as demand is being met by imports. Please keep in mind that a high trade deficit means that there are lots of dollars flowing out of the country to pay for all these doodads people are buying.

This means that those pesky foreigners who are holding all these dollars had better be partial to investing the greenbacks in US assets. Otherwise we might just see quite a few people who decide to sell their dollars for something else. This then boils down to a (cough) supply/demand imbalance and a consequent price adjustment to clear the market.

Now back to this week. After consumers said on Friday that they are still pretty confident but are adjusting their expectations for the future downwards, the manufacturers will tell us about their expectations today. Economists are expecting the NY Fed index to come in at around 30 which is still consistent with expansion. In all the backdrop is just to dark right now. People are afraid of terror, oil prices, collapsing equities and a whole raft of other things. It will take very many positive data points to counteract this kind of negativity.
11:13 AM :: Karsten :: permalink ::

Painting yourself into a corner?

Friday, August 13, 2004
This article from the WSJ (via the Australian Financial review) has a nice take on what a bind Sir Alan might be in. Some gems:

For two years, Alan Greenspan has stood on the deck of the American economy under a banner reading "Mission Accomplished".


Dr Greenspan and the Fed have boxed themselves in. After a few strong payroll reports and some inflation numbers that topped expectations earlier this year, the Fed's pledge of "patience" went out the window. The Fed then went on its current measured course to raise rates to maintain price stability and seemingly won't be deterred, even in the face of a sputtering economy.

As they say: rtwt!
11:05 AM :: Karsten :: permalink ::

Slowdown anyone?

Well it seems as if the consensus is slowly coming 'round to the idea that the US economy is in the process of slowing down. No real news there - it really is pretty uncontroversial to admit that the economy won't continue to grow at the heady pace we saw last year.

The problem is that some investors are now getting pretty nervous. People are asking themselves: "What if the slowdown turns out to be more violent than everybody thinks?" Add in serious headwinds by rising oil prices and the ever-present threat of terrorist action and you get a scenario in which perception is everything.

In this kind of scenario good isn't good enough. Normal economic and profits growth might lead to very negative market reaction. This year has been charaterized by a taking off of the rose-tinted glasses and a subsequent re-rating of market prospects. Lucky thing that there enough excuses out there (to steal a line from Barry Ritholz "Geopolitical tensions ate my portfolio").
10:49 AM :: Karsten :: permalink ::