I live in the USA and I am concerned about the future. I created this blog to share my thoughts on the economy and anything else that might catch my attention.
This is the End and a New Beginning
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I've been thinking about this for some time.
After 21 years of writing this blog almost daily, I've decided to stop
writing the daily updates on the blog.
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Silver Deep Dive
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Silver had a memorable year (+148%). Some of this can be explained by a
decline in the dollar. I decided to do some ML analysis to look for other
insights....
Most economists base much of their understanding of the economy on average and median income, savings, and debt data. Our very own Ben Bernanke looks to this type of data as seen in the Federal Reserve's Flow of Funds reports. There's just so much data to look at and the only way it seems even remotely manageable is to average it and summarize it.
I am now going to point out how this type of data can effectively hide problems within the economy and thereby confuse and shock mainstream economists as things fall apart. This is especially true when the problems start in subprime loans and are expected to remain there. The average person doesn't even have a subprime loan, right?
Consider the following two hypothetical economic situations. They are based on an economy with just three workers (which I have named "A", "B", and "C").
As seen through the eyes of "average" and "median" data, both situations are 100% identical. I would ask you these questions though.
1. Which situation is more unstable? 2. Which situation would be hurt most by rising oil prices? 3. Which situation would see payday loan stores become a growth industry?
I would argue that the economy as a whole is in far worse shape under situation #1 than it is under situation #2.
Deflation may be unlikely, but if it occurred, the consequences could be dire, and not just because of the direct economic impact. It would make dollars worth even more in the future, magnifying the U.S. government's surging debt burden. That could be the unspoken fear behind all that nervous talk.
There's nothing quite like an unspoken fear to generate plenty of hype. As we all know, the unspokenword of mouthcan spread like wildfire.
The following chart shows the Dow Jones Industrial Average adjusted for inflation (July 2010 dollars). It does not include dividends.
Click to enlarge.
The data is plotted on a log chart so that constant exponential growth is seen as a straight line.
It is an enhancement of achartthat I created about 6 years ago. That one wasn't adjusted for inflation but offered similar results.
The exponential trend line in green uses the low in June 1932 and the low in July 1982. The exponential trend line in yellow uses all of the data. The exponential trend line in red uses the high in August 1929 and the high in December 1999.
As a side note, I think the yellow line probably deserves to be parallel to the red and green lines. It's being tilted higher by our recent bubbles. I'm not adjusting for it though. I'm simply pointing it out.
Here's what the data looks like on a linear chart.
Click to enlarge.
Here are my conclusions.
If nothing has changed and we can assume all three long-term trends are therefore still in place then...
1. The average inflation adjusted fair value was 9,461 in July. 2. The potential downside risk was 3,106 in July. 3. The potential upside reward was 17,663 in July.
Let's assume that 9.5% unemployment, the lack of job creation for a full decade, and trillion dollar deficits don't constitute changes. They are just bumps in the road so to speak. Would it still seem rational to think that the DJIA would be trading above its average long-term fair value though?
What if things havechanged? What if it really is different this time? Then what?
I'm retired. I exited the stock market in 2004 at levels slightly above today's levels. I have no desire to come back unless I see a suitable bargain that can reward me for the risk I'd be taking. As seen in the chart, the lows of 2009 were clearly not sufficient to lure me back. They weren't even close to the green line. Today's levels have no chance.
I labeled Jim Cramer's advice back in May as a "Sarcasm FAIL". In hindsight, that was completely unacceptable. I apologize for underestimating the sheer size of the failure.
Given the new consumer optimism, good luck to anyone who wants to short this sector.
Here's an update to the stocks mentioned in the article.
Nordstrom: -28% Sears: -50% Guess: -17% J. Crew: -30% Gap: -31% Polo Ralph Lauren: -10% Coach: -13% Macy's: -12% Jones Apparel: -26% Tiffany: -12%
Average Decline: 23%
Wide diversification is only required when investors do not understand what they are doing. - Warren Buffett
Perhaps Jim Cramer should consider wide diversification. He apparently felt that retail stocks were the newwinners of the new world.
Compare and contrast...
Consider Nordstrom (JWN). I mean, what the heck? How can that stock be up this much on absolutely nothing? We have a story about how Sears (SHLD) basically doesn't have a real CEO, and the stock is up 20% in a month. - Jim Cramer, May 4, 2010
How did this bizarro world where nine-tenths of the companies I have followed as a stock picker for the last 20 years are losers and one-tenth are winners? To answer that question, you have to throw out all of the matrices and formulas and texts that existed before the Web. You have to throw them away because they can't make money for you anymore, and that is all that matters. We don't use price-to-earnings multiples anymore at Cramer Berkowitz. If we talk about price-to-book, we have already gone astray. If we use any of what Graham and Dodd teach us, we wouldn't have a dime under management. - Jim Cramer, February 29, 2000
As a side note, you really have to hand it to Sears. It's apillar of strength once again.
Here's a chart showing wage and salary disbursements as a fraction of personal income.
As seen in the chart, the long-term goal appears to be to phase out wages and salaries entirely and switch to a pure making money off of money wealth redistribution system. That should do wonders for our economy.
Unfortunately, the economy appears to do poorly when wages and salaries as a percent of personal income falls. You can also see the effect on a smaller scale within every single recession. It's almost like main street has a harder time shopping and paying bills when it does not have wages and salaries. Who knew?
Here's a conundrum for you. Wages and salaries as a percent of personal income have been falling throughout this recovery, just like they've been falling since 2000. Meanwhile experts like Jeremy Siegel feel that we should continue be as optimistic now as we were heading into 2000. Explain that.
Growth investors go wrong, however, when they try to pick a small handful of winners, Siegel said. You might end up with too much Coke and too little Lucent (or the opposite when their relative market value turns).
Here's a chart of Coke that comes up a bit flat and a fascinating story about how Lucent managed to raise its stock price in the aftermath of $26 billion losses. Enjoy!
If 10-year interest rates, which are now 2.8%, rise to 4% as they did last spring, bondholders will suffer a capital loss more than three times the current yield.
The investment could potentially lose as much as the S&P 500 has lost since May 1st and then potentially recoup those losses in the following months as higher interest rates once again freak out the weakened housing and stock markets? OMG! Bubble!! Sell! Sell all bonds!
We believe what is happening today is the flip side of what happened in 2000. Just as investors were too enthusiastic then about the growth prospects in the economy, many investors today are far too pessimistic.
The rush into bonds has been so strong that last week the yield on 10-year Treasury Inflation-Protected Securities (TIPS) fell below 1%, where it remains today. This means that this bond, like its tech counterparts a decade ago, is currently selling at more than 100 times its projected payout.
Why didn't I think to compare my TIPS to the tech stocks of 2000?
If we buy the 10-Year TIPS this very minute and hold it the full 10 years then...
1. We are GUARANTEED to get ALL of our money back, even if deflation strikes.
2. We are GUARANTEED to get an additional amount to compensate us for 10 years of inflation.
3. We are GUARANTEED to get an additional 0.96% per year in interest.
Yes sir. That's exactly like Jim Cramer'sWinners of the New World, well, once you strip out all the guarantees anyway.
I wish you could see my eyes rolling now. They've never moved this sarcastically before. I can't even keep them in the sockets. It's making me so dizzy that I'm tempted to vomit.
How will this all end? Ideally, before inflation takes hold in the U.S. and Europe, the costs in emerging economies will rise high enough for multinationals to invest and hire in the West again. I wouldn’t count on that. The average wage in the developed economies is 10 times that in emerging markets. There are five people in the latter for one in the former.
A more likely scenario is that the West will have to stop stimulus programs when inflation spreads to it from the emerging economies. The most immediate channel is through rising commodity prices. It’s a tax on the West to benefit emerging economies that produce raw materials. That’s the irony: The stimulus in the West can immediately bring harm to itself. It’s also the magic of globalization.
I turneddeflationaryon November 9, 2009. WTI crude oil was $79.44 on that day. As of today, it is now $75.77. The seasonally adjusted CPI was 216.859 in November 2009 and it was 217.597 in July 2010. That's a 0.34% increase (0.51% annual pace). I had hoped for a bigger bang for the deflationary buck.
I'm willing to stay deflationary through yet another Christmas season but then all bets are off.
I continue to own inflation protected treasuries and I-Bonds. That's my long-term plan to ride out the storm. I expect to experience pain, mostly through the taxation of the inflationary gains if serious stagflation does appear.
China's housing oversupply isn't surprising. Excess supply reflects the under-pricing of capital, and China's system is structured to increase supply quickly. But rising prices alongside rising vacancy rates are surprising. Normally, speculators are spooked by high vacancy rates. But China's phenomenon is unique for at least four reasons:
I will leave that as a teaser. The article deserves to be read in its entirety.
And lastly, if Andy Xie is right then the 1970s will look like a picnic by comparison. We'll be heading into a stagflationary environment with unemployment already high. Ouch.
Interest earned on 90-day Treasury bills below the inflation rate is a signal for governments to try to stop deflation and reflate the economy. When this happens, gold becomes attractive. We are in such an environment now.
That's really good to know. So if interest earned on 90-day Treasury bills is 10% but the inflation rate is 12% then that will be a signal for governments to try to stop deflation and reflate the economy. No wonder the 1970s were so awesome for gold. The government spent nearly the entire decade successfully fighting deflation. Who knew?
The twin engines of negative real interest rates and government deficits tend to make gold a very attractive investment. Recent research supports our historical findings on what drives gold.
So deflationary environments are known for their negative real interest rates? I mistakenly thought that was a stagflationary environment. I stand corrected!
The Federal Reserve’s main interest rate is near zero and inflation is a little over 1 percent, so we now find ourselves in a negative real interest rate situation.
So if inflation is a little over 1 percent, then this would still count as a deflationary environment? It's like everything I ever thought I knew was wrong.
I'm almost convinced. I'm earning a little over 1 percent in my ING Direct savings account and inflation is a little over 1 percent. I clearly wouldn't want to lose too much of my purchasing power by continuing to do that. Perhaps I should move money into something that's risen 400% over the last decade just to be completely safe. Hey, maybe I can even borrow money at these incredibly low interest rates and leverage up my bet. It sounds like a sure thing.
I still need to know why gold's price fell in late 2008 as oil crashed in a spectacular way and housing crumbled though. That part is still confusing to me. If that wasn't a deflationary environment, then what was it?
As I look to his charts for more insight, I see that the low gold prices of the 1990s eventually led to cuts in exploration, which led to falling production, which led to higher gold prices. That will be especially good to know if I ever find myself back in the 1990s again.
I thank CEO Frank Holmes for his unbiased gold insights and hope that his World Precious Minerals Fund (UNWPX) and his Gold and Precious Metals Fund (USERX) do well for both him and his company.
I now understand why investorslove goldin inflationary environments, deflationary environments, andat any price. It all makes sense now.
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