tag:blogger.com,1999:blog-22623294151991306902024-03-19T04:48:37.614-04:00Morally BankruptThis is definitely not progressAnonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.comBlogger123125tag:blogger.com,1999:blog-2262329415199130690.post-10617501235226124852015-04-28T02:50:00.002-04:002015-04-28T02:50:25.452-04:00A short guide to measures of employment, wages and income<!--[if gte mso 9]><xml>
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Over the last few years I’ve spent a lot of time discussing
employment with various other market participants, commentators, reporters and
other assorted interested observers and, in my experience, one of the biggest
obstacles to productive exchange is an incomplete understanding of the various
measures of income & employment, what they attempt to estimate and how the
estimates are arrived at. I put together this short description, which I hope
to keep updating in the future, in an attempt to create a quick reference to
various measures of employment, wages and income both for myself and colleagues. </div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
To avoid any confusion related to nomenclature, it’s
important to define some of the terms that I will use and how they relate to
each other. The <i style="mso-bidi-font-style: normal;">labor force</i> is the
portion of the population that is <i style="mso-bidi-font-style: normal;">employed</i>,
<i style="mso-bidi-font-style: normal;">unemployed</i>, or <i style="mso-bidi-font-style: normal;">discouraged</i><span style="mso-no-proof: yes;"><span style="mso-spacerun: yes;"> </span>(1)</span>. Estimates of the
labor force, (un)employment levels, and demographic characteristics of the
labor force come from the <a href="http://www.bls.gov/cps/">Current Population
Survey</a> (CPS), commonly referred to as the “household survey”, collected from
a sample of 60,000 households by the Bureau of Census for the Bureau of Labor
Statistics (BLS). Some key definitions are reproduced below:</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal" style="margin-left: .5in;">
<i style="mso-bidi-font-style: normal;">Employed</i>
persons consist of: persons who did any work for pay or profit during the
survey reference week; persons who did at least 15 hours of unpaid work in a
family-operated enterprise; and persons who were temporarily absent from their
regular jobs because of illness, vacation, bad weather, industrial dispute, or
various personal reasons.</div>
<div class="MsoNormal" style="margin-left: .5in;">
Persons are classified as <i style="mso-bidi-font-style: normal;">unemployed</i> if they do not have a job,
have actively looked for work in the prior 4 weeks, and are currently available
for work. Persons who were not working and were waiting to be recalled to a job
from which they had been temporarily laid off are also included as unemployed.</div>
<div class="MsoNormal" style="margin-left: .5in;">
<i style="mso-bidi-font-style: normal;">Discouraged</i>
workers are a subset of persons marginally attached to the labor force. The
marginally attached are those persons not in the labor force who want and are
available for work, and who have looked for a job sometime in the prior 12
months, but were not counted as unemployed because they had not searched for
work in the 4 weeks preceding the survey.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
In addition to the household survey, the BLS also conducts
the <a href="http://www.bls.gov/ces/">Current Employment Statistics</a> (CES) survey,
commonly referred to as the “establishment survey” because it surveys
establishments (employers). It covers about 143,000 employers which, in
aggregate, employ over 588,000 persons<span style="mso-no-proof: yes;"><span style="mso-spacerun: yes;"> </span>(2)</span>. The establishment
survey includes any full- or part-time worker that was paid during the pay
period that includes the 12<sup>th</sup> of the month excludes self-employed
workers, farm workers, domestic workers and non-civilian government workers. In
addition to estimates of payroll employment, the establishment survey provides
estimates of hours worked and hourly earnings for the estimated 77.2 million
workers paid at hourly rates<span style="mso-no-proof: yes;"><span style="mso-spacerun: yes;"> </span>(3)</span>.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
I will use the word “worker” to describe a member of the
labor force and the word “employee” for a person on an establishment’s payroll.
It is important to note that because an employed worker may be employed by zero
(e.g. in the case of self-employed) or more establishments, these are not
interchangeable. The household survey counts as “employed<i style="mso-bidi-font-style: normal;">” </i>workers who may or may not be on a payroll, while an employee is
a worker that is currently on a payroll. The sum of all the remuneration
employees receive for their work is <i style="mso-bidi-font-style: normal;">compensation.</i>
</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
An estimate of <a href="http://research.stlouisfed.org/fred2/series/COE">Compensation of
Employees</a> is released quarterly by the Bureau of Economic Analysis (BEA) as
part of the National Income accounts. Compensation of employees is the sum of <a href="http://research.stlouisfed.org/fred2/series/WASCUR">wages and salaries</a>
and <a href="http://research.stlouisfed.org/fred2/series/A038RC1Q027SBEA">noncash
benefits</a> (e.g. retirement plan contributions and employer-provided health
care plans) paid or provided to US residents by US or foreign employers.<span style="mso-no-proof: yes;"><span style="mso-spacerun: yes;"> </span>(4)</span> This measure can
effectively be thought of as the “labor share” of income. It is important to
note that this measure excludes income from self-employment, including what is
commonly referred to as “1099 income,” non-employee compensation paid to
independent contractors, which is recorded as <a href="http://research.stlouisfed.org/fred2/series/PROPINC">Proprietor’s Income</a>.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<a href="http://research.stlouisfed.org/fred2/series/A576RC1">Wage
& Salary Disbursals</a>, a monthly estimate which is lagged by one month is
an almost perfect proxy for the wages & salaries portion of compensation of
employees. This measure represents the actual aggregate compensation that
employers paid both wage and salary employees and is a function of employment
levels, salaries, hours worked and the rate at which those hours were paid,
including overtime and paid time off. This measure deviates slightly from the
quarterly series in that it is based on disbursements while the quarterly
series is based on accruals. </div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
The two most popular measures of employment are the
establishment survey’s <a href="https://research.stlouisfed.org/fred2/series/PAYEMS">non-farm payrolls</a>
(NFP), an estimate for the number of jobs in the universe covered by the
establishment survey, and the <a href="https://research.stlouisfed.org/fred2/series/LNU02000000">employment
level</a> estimate from the household survey. As previously mentioned, these
measures are not equivalent, but the closest measure to NFP in the household
survey is probably <a href="https://research.stlouisfed.org/fred2/series/LNS12032187">Employment
Level - Nonagriculture, Wage and Salary Workers</a>. As can be seen clearly <a href="http://research.stlouisfed.org/fred2/graph/?g=19fo">here</a>, the
difference between the two is explained almost entirely by multiple jobholders.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<a href="https://research.stlouisfed.org/fred2/series/AWHAETP">Average Weekly
Hours</a> and <a href="https://research.stlouisfed.org/fred2/series/AWHNONAG">Average
Weekly of Production and Nonsupervisory Employees</a> are measures of hours
worked (not scheduled). It is calculated by dividing the total weekly hours by
the number of employees paid for those hours for a cell and then calculating a
weighted average across industries<span style="mso-no-proof: yes;"><span style="mso-spacerun: yes;"> </span>(2)</span>. </div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
<a href="http://research.stlouisfed.org/fred2/series/CES0500000003">Average Hourly
Earnings</a> and <a href="http://research.stlouisfed.org/fred2/series/AHETPI">Average
Hourly Earnings of Production and Nonsupervisory Employees</a> are <i style="mso-bidi-font-style: normal;">not </i>measures of wage rates. They are aggregate
measures of the amounts paid to workers which may include distortions such as
overtime or holiday pay or fluctuations in the proportion of hours worked by
higher or lower waged workers. They are calculated by dividing the sum of the
payroll by the total hours worked for a cell and then calculating a weighted
average across industries. It’s important to note that these series <i style="mso-bidi-font-style: normal;">cannot </i>be used as a measure of wage
inflation as they do not control for overtime or the composition of the
workers. For example, in a rising wage environment that coincides with an
increase in low wage employees and an increasing number of hours worked by
those employees, average hourly earnings could fall even though a measure that controlled
for occupation would rise. Special bonuses and non-cash compensation are not
reflected in this measure.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Multiplying the estimates of average hourly earnings and
average weekly hours would result in an estimate of average weekly earnings,
the average gross weekly pay for an hourly position before any deductions (such
as payroll and income taxes, health plan deductions, etc.) which are available
on a monthly periodicity; however, a better measure of hourly earnings is
released quarterly based on the household survey. <a href="http://www.bls.gov/news.release/wkyeng.toc.htm">The Usual Weekly Earnings
of Wage and Salary Workers</a> as part of the provides an estimate of quantile
boundaries of weekly earnings before taxes and other deductions<span style="mso-no-proof: yes;"><span style="mso-spacerun: yes;"> </span>(5)</span> which control for various
demographic factors as well as weighted aggregates meant to be representative
of the population. <span style="mso-spacerun: yes;"> </span>In contrast to all
the previous data series mentioned, this release holds information as to the <i style="mso-bidi-font-style: normal;">distribution </i>of earnings and allows us
to see where changes in wages and employment are happening in the context of <a href="https://research.stlouisfed.org/fred2/release/tables?rid=332&eid=46373">sex</a>,
age, race, <a href="https://research.stlouisfed.org/fred2/release/tables?rid=332&eid=46964">occupation</a>,
full- or part-time status, and <a href="https://research.stlouisfed.org/fred2/release/tables?rid=332&eid=47819">educational
attainment</a>.</div>
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
Together, these measures give us an idea of how money is
paid by employers, to how many people, as well as how that income is
distributed and the aggregate utilization of hourly workers. However, none of
these measures are a true measure of wage inflation, although the median of earnings
of full-time employees by occupation can be close. For a closer look at wage
inflation we have to look at the <a href="http://www.bls.gov/ect/">National
Compensation Survey</a> (NCS).</div>
<div class="MsoNormal" style="margin-top: 12.0pt;">
The NCS is a quarterly
establishment-based survey that provides comprehensive measures of employer
costs for employee compensation, compensation trends, and the incidence of
employer-provided benefits among civilian workers, excluding federal,
quasi-federal workers, overseas, and self-employed workers<span style="mso-no-proof: yes;"><span style="mso-spacerun: yes;"> </span>(6)</span>. The two main
components of the NCS are the <a href="https://research.stlouisfed.org/fred2/release?rid=11">Employment Cost
Index</a> (ECI) and <a href="http://www.bls.gov/news.release/ecec.toc.htm">Employer
Costs for Employee Compensation</a> (ECEC). The ECI, one of the better measures
of compensation inflation, provides a “measure of the change in the cost of
labor independent of employment shifts amongst occupations and industry
categories” and its composition by occupational groups and industry
supersectors grouped into private sector or state & local employers. The
ECI tracks changes in compensation within establishment jobs, not individuals,
so an employee being promoted or changing jobs within the establishment would not
affect the index. While the ECI measures changes in per employee hour <i style="mso-bidi-font-style: normal;">wages paid to employees </i>and is presented
as an index level, the ECEC measures changes in the cost of per employee hour <i style="mso-bidi-font-style: normal;">cost to employers </i>and is presented in
dollar amounts. </div>
<div class="MsoNormal" style="margin-top: 12.0pt;">
Finally, the US Treasury provides
a daily record of assorted deposits and withdrawals in the <a href="https://www.fms.treas.gov/dts/index.html">Daily Treasury Statement</a> (DTS)
which includes deposits for “Withheld Income and Employment Taxes,” the portion
of gross pay that employers withhold for income and FICA tax purposes. In contrast
to numbers from the previously mentioned releases, this is <i style="mso-bidi-font-style: normal;">not</i> an estimate and is <i style="mso-bidi-font-style: normal;">not</i>
revised. It is a true, real-time indicator of aggregate wages disbursed and can
be used as a proxy until Wage & Salary Disbursals data is ready later-on.
It is important to note that, because deposits for withholdings are not
necessarily made simultaneously with payroll (the Treasury allows for a short
lag between disbursal and deposit) and payroll periodicity varies between
establishments, short-term periods will be noisy and this data can’t be used to
approximate month-to-month changes in the seasonally-adjusted annual rate of disbursals
without significant adjustments. In particular, deposits tend to be elevated on
common “paydays” like Friday, Monday, and the turn of the month. </div>
<h1 style="text-align: center;">
<span style="font-size: large;">Works Cited</span></h1>
<div class="MsoBibliography">
<span style="mso-no-proof: yes;">1. <b>Bureau of Labor Statistics.</b> Labor Force
Statistics. <i>Current Population Survey. </i>[Online] April 2015.
http://www.bls.gov/cps/lfcharacteristics.htm.</span></div>
<div class="MsoBibliography">
<span style="mso-no-proof: yes;">2. —. Technical Notes
for the Current Employment Statistics Survey. <i>Current Employment
Statistics. </i>[Online] April 2015. http://www.bls.gov/web/empsit/cestn.htm.</span></div>
<div class="MsoBibliography">
<span style="mso-no-proof: yes;">3. —. Minimum wage
workers: Characteristics of minimum wage workers, 2014. <i>Current Population
Survey. </i>[Online] April 2015.
http://www.bls.gov/opub/reports/cps/characteristics-of-minimum-wage-workers-2014.pdf.</span></div>
<div class="MsoBibliography">
<span style="mso-no-proof: yes;">4. <b>Bureau of
Economic Analysis.</b> Methodology Papers. <i>Bureau of Economic Analysis. </i>[Online]
November 2014. http://www.bea.gov/national/pdf/chapter10.pdf.</span></div>
<div class="MsoBibliography">
<span style="mso-no-proof: yes;">5. <b>Bureau of Labor
Statistics.</b> Usual Weekly Earnings Technical Note. <i>Current Population
Survey. </i>[Online] April 2015.
http://www.bls.gov/news.release/wkyeng.tn.htm.</span></div>
<div class="MsoBibliography">
<span style="mso-no-proof: yes;">6. —. Handbook of
Methods, Chapter 8, National Compensation Measures. <i>National Compensation
Survey. </i>[Online] http://www.bls.gov/opub/hom/pdf/homch8.pdf.</span></div>
<div class="MsoNormal">
<br /></div>
Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com42tag:blogger.com,1999:blog-2262329415199130690.post-53552155555125112422015-01-21T23:38:00.000-05:002015-01-21T23:38:56.752-05:00Labor: To the Moon!A year ago I wrote about the coming sectoral re-balancing, with a focus on the <a href="http://blog.morallybankrupt.org/2013/12/profit-margins-tax-receipts-and-labor.html">imminent increase in the share of labor income at the expense of corporate profits</a> due to an increase in labor bargaining power, declining labor slack, recovering aggregate demand, and increase in public sector employment as a result of improving tax receipts. Let's re-visit how this all panned out. Capital formation? Up as both <a href="http://research.stlouisfed.org/fred2/graph/?g=XW5">Net Investment</a> and <a href="http://research.stlouisfed.org/fred2/graph/?g=XW4">capex</a> increased.<br />
<br />
The average YoY% increase in <a href="http://research.stlouisfed.org/fred2/graph/?g=XVV">aggregate wage and salary disbursals</a> was 4.3%, north of the 4% average increase for the first three quarters in nominal GDP.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiB_Gbz49gYyOvSmzJTfaxA71VnZ7iQlbWVL4HmHtNf7TNTM-387yQbogGjZseZEmcDZ9wxi0fCE3LXsEiuvy9q86s-z7gmfpchoHHNl5g1CwoI13dFhlHLay1zgIFbvJAedJ9uT8YCzOyL/s1600/Wage+disbursals+2014-12.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiB_Gbz49gYyOvSmzJTfaxA71VnZ7iQlbWVL4HmHtNf7TNTM-387yQbogGjZseZEmcDZ9wxi0fCE3LXsEiuvy9q86s-z7gmfpchoHHNl5g1CwoI13dFhlHLay1zgIFbvJAedJ9uT8YCzOyL/s1600/Wage+disbursals+2014-12.png" height="265" width="400" /></a></div>
<br />
<br />
Also showing robust growth, was Income & Employment Tax Withheld (the stuff withheld on your paycheck) which increased a total of 5.3% for the year as a whole, a clear indicator that more people earned more money. <br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGCbbccOVjH9EbmkCP09yotWQlXqxYZAqojGV0JlpQQbaynJHwDItyMKkCk9FsB2IpjVJAv4y_sIvmsYW5so1d0JAeIbJyrUQH29R87Utv337W2cPJnglA1SO7Twa3O3aZNxTYw3cHHSYx/s1600/tax+withholding+2014-12.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGCbbccOVjH9EbmkCP09yotWQlXqxYZAqojGV0JlpQQbaynJHwDItyMKkCk9FsB2IpjVJAv4y_sIvmsYW5so1d0JAeIbJyrUQH29R87Utv337W2cPJnglA1SO7Twa3O3aZNxTYw3cHHSYx/s1600/tax+withholding+2014-12.png" height="240" width="400" /></a></div>
<br />
And, for those who think we still have a lot of labor slack to work through, I present the following chart. At the current pace of job gains, we are a couple of months away from<a href="http://research.stlouisfed.org/fred2/graph/?g=Xtn"> full employment</a>. As the blue line falls below zero, labor bargaining power should really hit traction leading to the increase in real wages and inflation that will eventually lead to the next recession (which is still years away).<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhawSq3erUDxJwPT0wN9UsVCAVwl3EU18NlzMBGVnUcESyRRMBJk4KQWdzoIaYpGqM62461JtyMoHyu4CBy1vYTM12DGAp_-bbEFEiOgKB3V_A6kQaW8lRh2I5C1Lhqwuf2nhpPHpk8EuXV/s1600/employment+gap+2014-12.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhawSq3erUDxJwPT0wN9UsVCAVwl3EU18NlzMBGVnUcESyRRMBJk4KQWdzoIaYpGqM62461JtyMoHyu4CBy1vYTM12DGAp_-bbEFEiOgKB3V_A6kQaW8lRh2I5C1Lhqwuf2nhpPHpk8EuXV/s1600/employment+gap+2014-12.png" height="265" width="400" /></a></div>
<br />
<br />
Far from being a drag on the labor force like it was last year,<a href="ttp://research.stlouisfed.org/fred2/graph/?g=XVU"> public sector employment</a> has now become an impulse tighter, and it's growing at an accelerating rate, with a whole lot of room to run as those increasing tax receipts translate into new jobs.<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQUrFnjdWf7pCFc3_FsZXHQ282l6_Wc3uTXbo_X0dsBj9KUcEpgAZsLttICz4Ku2KzEVBSCaAqeMoXjFUyINxORu5BQK5AmkW9cEbP4fuGXc8jAU_jkRixzAqqLzuvvI3LAlzf8r6JjArV/s1600/pub+sector+employment.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQUrFnjdWf7pCFc3_FsZXHQ282l6_Wc3uTXbo_X0dsBj9KUcEpgAZsLttICz4Ku2KzEVBSCaAqeMoXjFUyINxORu5BQK5AmkW9cEbP4fuGXc8jAU_jkRixzAqqLzuvvI3LAlzf8r6JjArV/s1600/pub+sector+employment.png" height="265" width="400" /></a></div>
<div class="separator" style="clear: both; text-align: center;">
</div>
<br />
<br />The corporate sector will try to cut costs but Q1, 2 & 3's<a href="https://research.stlouisfed.org/fred2/series/B075RC1Q027SBEA"> federal government tax receipts on corporate income</a> for were 21.6%, 38.1%, and 33.9% higher than the previous year leading to a SAAR of over 500B in corporate income taxes paid. For <a href="https://www.cbo.gov/sites/default/files/cbofiles/attachments/49867-MBR.pdf">calendar Q4</a> (fiscal 1Q15) the increase was even larger at 41.8% YoY (no seasonal adjustments). The effective tax rate of the corporate sector is going nowhere except up until legislation changes it or we get another recession. The marginal dollar of sales goes increasingly to the workers and the government. If you believe in micro theory, this is the aggregate result of firms increasing the quantity supplied until marginal net profit is close to zero. <br />
<br />
As I said <a href="http://blog.morallybankrupt.org/2014/01/personal-savings-rate-and-balance-of.html">last year</a>, the gap in quality between the mean and median household balance
sheets (wealth skew) has probably peaked and is headed nowhere but
down and the accumulated stock of corporate sector
savings is being transferred to the household and public sectors. We are way past #PeakPiketty. <br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWsYNR8jE367_TBFil8O6yZojz_GnLCZXTKWlHob1p7EASMLOqUi3TJKMfKXm6zz0ga-wovezsNCxDwIJQVWJtfcM84HcBQ4dOX2IUQq_JmHlJX1prvuL3cl9obENa9yLsacZDAi7Md6zC/s1600/USA_Sex_by_Age_20140601.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWsYNR8jE367_TBFil8O6yZojz_GnLCZXTKWlHob1p7EASMLOqUi3TJKMfKXm6zz0ga-wovezsNCxDwIJQVWJtfcM84HcBQ4dOX2IUQq_JmHlJX1prvuL3cl9obENa9yLsacZDAi7Md6zC/s1600/USA_Sex_by_Age_20140601.png" height="209" width="320" /></a></div>
<br />
<br />
We are only getting started and labor is only going to get tighter from here until the next recession from a cyclical perspective. Additionally, as the growth in the millennial "echo boom" is increasingly digested into the labor force and retirement of the baby boomers progresses, it is likely that we will not see another large expansion of the workforce until millennial' kids enter it, and given low birth rates, that's not going to happen for another 2-3 decades. It's going to be a long, long ride UP for labor, and anyone betting on technological unemployment, secular stagnation, continuing rentierism or cost-push deflation is going to miss one hell of a p&l party. Oh, and for those worried about what CEOs get paid: It's going to be a lot harder to get large bonuses and raises for executives when net margins are declining in the midst of an expansion. Expect increasing pressure on executive compensation as traditional measures of profitability and efficiency decline.<br />
<br />
And, just to clarify one more time: labor tightness, labor bargaining power, and wages are going nowhere except UP. And wealth/income-skew (sometimes called "inequality") is going nowhere but down.<br />
<br />Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com15tag:blogger.com,1999:blog-2262329415199130690.post-4321527148945262902014-01-20T02:01:00.001-05:002014-01-20T02:01:54.700-05:00Personal Savings Rate and the Balance of Payments<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; margin-left: 1em; text-align: right;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhqllrau-byrlLd346rzRew0XMdNCVaXRsIP1hVxDFCQlnECZEnCziC_mT4KTvhmiBsWt0rsjmWon1DeLX8Dzz78gX6xIrk9RcS1Vv7xJSAhKXXXant_HKOacdvrpMxtyIQWuBnp4UmUkAf/s1600/CA+vs+PS.png" imageanchor="1" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhqllrau-byrlLd346rzRew0XMdNCVaXRsIP1hVxDFCQlnECZEnCziC_mT4KTvhmiBsWt0rsjmWon1DeLX8Dzz78gX6xIrk9RcS1Vv7xJSAhKXXXant_HKOacdvrpMxtyIQWuBnp4UmUkAf/s1600/CA+vs+PS.png" height="240" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Personal Savings Rate & Current Account Balance. Source: <a href="http://research.stlouisfed.org/fred2/graph/?g=r9v">FRED</a></td></tr>
</tbody></table>
One of the most common--and yawn-worthy--criticisms of my <a href="http://blog.morallybankrupt.org/2013/12/profit-margins-tax-receipts-and-labor.html">December post</a> outlining why<a href="http://blog.morallybankrupt.org/2013/12/more-on-labor-bargaining-power.html"> the rise of labor bargaining power</a> was going to be very negative for corporate profits (my estimated CAGR for the next 20y is 1.65% nominal on the upper end) was that corporate profits would be able to survive an increase in real wages because nominal demand would expand at a greater-than or equal-to rate as wages. When confronted with the fact that this would necessitate a lower savings rate, an anonymous reader stated that the savings rate would decline because, "it's demographic." This is, of course, total nonsense. Although the baby-boomers will indeed draw down their stock of savings as they retire, these are most likely to be offset by rising stock of savings of the echo boom and millennials resulting from higher employment and real wages.<br />
<br />
Arguing for a decline in the personal savings rate means--by definition--an increase in the rate of growth of one or more of the following in excess of the rate of growth in personal income:<br />
<ul>
<li>Corporate savings (profits - dividends)</li>
<li>Government savings (budget balance)</li>
<li>Foreign savings (current account deficit)</li>
</ul>
The first, as I indicated in my December post, is not happening.The second one, a contracting deficit is currently taking place as a result of the labor recovery and the last is actually in contraction. It is this last one I want to talk about here.<br />
<br />
Although the causality is bidirectional, the savings rate is intimately tied to the balance of payments by the accounting entity <a href="http://en.wikipedia.org/wiki/Balance_of_payments#Rebalancing_by_adjusting_internal_prices_and_demand">CA= NS-NI</a> (Current Account Surplus = National Savings - National Investment). As such, a revisiting of the low savings rates associated with the 2000s would need to be coincident with a much much larger current account deficit and tighter fiscal policy. The main driver in the 2000s for this were the so-called "Clinton surplus" followed by the large current account deficit.<br />
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgi5aU48DMNxrhC0zEB7HxRhJ71bpwxhDkX67IB7VK0Gtaj2qS5PVQ06e9YAUNGtKSm2uslR2rT9X-WZoVoV8UYwxblBoh0Shtqdz2rzd3H6KHTK25TloZWxB4P21ZFnJxnR129qUkekJaJ/s1600/petro_other_liquids_line.png" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgi5aU48DMNxrhC0zEB7HxRhJ71bpwxhDkX67IB7VK0Gtaj2qS5PVQ06e9YAUNGtKSm2uslR2rT9X-WZoVoV8UYwxblBoh0Shtqdz2rzd3H6KHTK25TloZWxB4P21ZFnJxnR129qUkekJaJ/s1600/petro_other_liquids_line.png" height="320" width="295" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source <a href="http://www.eia.gov/energy_in_brief/article/foreign_oil_dependence.cfm">EIA</a></td></tr>
</tbody></table>
As <a href="http://www.ft.com/intl/cms/s/0/ab25d64a-77e8-11e3-afc5-00144feabdc0.html#axzz2qt2qvDeP">increases in petroleum production cause imports to decline</a>, the portion of the trade balance associated with petroleum declines. Additionally, the ongoing rebalancing of the Chinese economy towards consumption (as well as the <a href="http://finance.yahoo.com/q/bc?s=CNYUSD=X&t=5y&l=on&z=l&q=l&c=">ongoing RMB revaluation</a>) will continue to drag on China's current account surplus--and, in my opinion, turn it into a deficit--making the return of 6% current account deficits highly unlikely.<br />
<br />
There is quite a few reasons to be bullish on increases in nominal final demand, but <i>a decline in the personal savings rate is not one of them.</i> The gap in quality between the mean and median household balance sheets (wealth skew) has probably peaked and is headed nowhere but down. As I have said before, the accumulated stock of corporate sector savings is about to be transferred to the household and public sectors. Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com23tag:blogger.com,1999:blog-2262329415199130690.post-79422197639587676272013-12-13T03:41:00.000-05:002013-12-13T03:41:52.171-05:00Even more evidence of shifts in labor markets<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjr05ChoUyZB61sYEfO-M1oCo4SEee6QypHGC_KzOBnvc38EcjUTpXQwcB6BsN6YAwhz-pId4C9fIwLYUjy9V7LH_7j4bV0RnL9vHpSBFnmkzqtCGmkYXMFdvLir4Fx1a7Jr6EsnMdCE_mZ/s1600/2013-12-13+ECSU.PNG" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjr05ChoUyZB61sYEfO-M1oCo4SEee6QypHGC_KzOBnvc38EcjUTpXQwcB6BsN6YAwhz-pId4C9fIwLYUjy9V7LH_7j4bV0RnL9vHpSBFnmkzqtCGmkYXMFdvLir4Fx1a7Jr6EsnMdCE_mZ/s1600/2013-12-13+ECSU.PNG" height="192" width="320" /></a>The following charts are part of December 13's Bloomberg Economics Brief. The top chart is Bloomberg's Economic Surprise Index. As you can probably notice, the labor market has been surprising significantly to the upside lately. On the bottom, is changes in nominal wages for the month of November by selected industry. The red line represents the Fed's symmetrical target for inflation while the yellow highlight indicates value of the year-over-year percent change in the PCE deflator. <br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxTUej6tZilZVxS6J2xlsoqyaKSMcQhqs43QzhmNfDnXUl2fkjWt8zvI-MqpxlNOTzLJ9jyMX9oWMpBMGFBN3ECCnfuker5aQGiyJ4x7brnoCdiedorBBfVxnGpt0oK-Ku1qqzY2Oe3bM2/s1600/2013-11+wages+by+sector.PNG" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxTUej6tZilZVxS6J2xlsoqyaKSMcQhqs43QzhmNfDnXUl2fkjWt8zvI-MqpxlNOTzLJ9jyMX9oWMpBMGFBN3ECCnfuker5aQGiyJ4x7brnoCdiedorBBfVxnGpt0oK-Ku1qqzY2Oe3bM2/s1600/2013-11+wages+by+sector.PNG" height="205" width="320" /></a></div>
<br />
While wage growth leaves lots to be desired, all but two industries, utilities and Leisure & Hospitality, showed wage increases in excess of PCE deflator increases. This is good news, these are real wage increases and more evidence of labor market tightening, even if very marginal. This is my 3d post in 2 weeks about this and you better get used to them, because there's probably going to be a lot more of them. The tide is changing, and <i>labor is on its way up</i>!<br />
<br />
<b>Previously:</b><br />
<a href="http://blog.morallybankrupt.org/2013/12/more-on-labor-bargaining-power.html">2013-12-12 -- More on labor bargaining power</a><br />
<a href="http://blog.morallybankrupt.org/2013/12/profit-margins-tax-receipts-and-labor.html">2013-12-05 -- Profit margins, tax receipts, and labor demand curves</a>Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com18tag:blogger.com,1999:blog-2262329415199130690.post-30051049377356792152013-12-12T03:16:00.000-05:002013-12-12T22:13:12.074-05:00More on labor bargaining powerLast week I wrote about how a number <a href="http://blog.morallybankrupt.org/2013/12/profit-margins-tax-receipts-and-labor.html">highly reliable indicators are indicating the bargaining power of labor is increasing</a> and that it will lead to tighter labor markets and wage inflation.<br />
<br />
On Nov 26, The New York Times reported that <a href="http://www.nytimes.com/2013/11/27/nyregion/with-new-agreement-nyu-would-again-recognize-graduate-assistants-union.html?_r=0">NYU will once again recognize the graduate assistants' union</a>. The voting was scheduled to take place this week, but a search of press releases shows no results yet as to the outcome. Excerpt below, emphasis mine.<br />
<blockquote class="tr_bq">
Some 1,200 graduate assistants at N.Y.U. and the Polytechnic Institute
of N.Y.U. in Brooklyn are scheduled to vote on Dec. 10 and 11 on whether
to join the union...</blockquote>
<blockquote class="tr_bq">
An issue that had long prevented agreement between N.Y.U. and the union
was whether graduate research assistants in the natural or physical
sciences could be included in the union. <i>The university argued that the
research those assistants did was an essential part of their academic
training, and should not be viewed as employment.</i> In their statement,
the union and N.Y.U. acknowledged that they had not resolved their
differences over whether the 275 graduate research assistants in the
so-called hard sciences had bargaining rights. They will therefore not
be included in the union. </blockquote>
NYU's claim that the work (<i>they</i> called it "work") their research assistants do is part of their training, they are acknowledging it is, indeed, work. As with the recent <a href="http://www.nytimes.com/2013/06/12/business/judge-rules-for-interns-who-sued-fox-searchlight.html">unpaid intern cases,</a> some will argue that this is not valuable enough to be compensated and the benefit of it mostly accrues to the employee/intern/assistant but, if their labor is truly of so little use, maybe they should be free to apply those resources elsewhere. Like in the intern cases, the labor slack as a result of the financial crisis created a large number of people who wanted work and were willing to sacrifice wages in the hopes that experience would be worth something and make it easier to find a paying job in the future. This shift right in the labor supply curve would have led to <a href="http://research.stlouisfed.org/fred2/graph/?g=pw0">lower clearing price</a> for labor, the evidence of which is <a href="http://advisorperspectives.com/dshort/updates/Median-Household-Income-Update.php">everywhere</a>. Whether this was unfairly exploited or not is up for the judges to decide, but what seems self-evident to me is that the trough in the bargaining power of labor is behind us and, as a result, the labor consumer <a href="http://en.wikipedia.org/wiki/Economic_surplus">surplus</a>--in the neoclassical sense. remember, employers are consumers of labor--is about to be redistributed.<br />
<br />
At the risk of oversimplifying, but in the interest of avoiding a black-hole, I will skip discussion of dead-weight losses, the welfare state and heterodox theories of economic surplus, and simply say this: If you believe any of the following:<br />
<ul>
<li>welfare initiatives like the <a href="http://en.wikipedia.org/wiki/Earned_income_tax_credit">Earned Income Tax Credit</a> subsidize low salaries leading to a higher quantity of labor supplied at a point below the incentive-free equilibrium</li>
<li>price elasticity of supply of labor flattens significantly on the left side (positive first derivative)</li>
<li>some people will agree to work for less to build a resume or gain experience</li>
</ul>
Then, the logical conclusion is that, as labor markets recover, the lions share of the benefits will accrue to the household and public sectors. Not only on the marginal increase of production (a change in quantity or labor demanded), but on the <i>entire</i> level of production (a shift in the demand curve).<br />
<br />
The corporate rent-seekers masquerading as capitalists will argue the corporate sector will simply not hire or invest if faced with rapidly declining margins or increasing costs at the margin, but the truth is that almost 3 decades where <a href="http://advisorperspectives.com/dshort/updates/Household-Income-Distribution.php">productivity gains have disproportionally accrued to capital</a> and record-high profit margins mean that the ability of capital to bring a credible bluff is just about non-existent. This trend is going to be with us for a long, long time.<br />
<br />
<b>UPDATE:</b> The NYU <a href="http://www.thenation.com/blog/177573/nyu-grad-students-vote-unionize#">vote was overwhelmingly for organization</a> and both parties expect to have completed a contract by the end of the academic year.<br />
<b>UPDATE-2:</b> "<a href="http://finance.yahoo.com/news/machinists-reject-boeing-labor-contract-025752549.html?soc_src=mediacontentstory">Machinists reject Boeing labor contract offer</a>" Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com7tag:blogger.com,1999:blog-2262329415199130690.post-69395071927674261042013-12-10T08:30:00.000-05:002013-12-10T08:30:05.130-05:00Corporate Debt / Market Cap as a predictor of forward returns<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgOjwLH47OAPrppwHwhy_ioHVUZlWxhDDxuYCQuNkOpWGvJZH_4-OiSwMPEkW8zPS1ZOFgKSXPuN8_STorES7Lnnop9ltXlMRdfrxdSS3A3M54PXPRu5AAHLW_es0FczbGkAfW1tuHIi6CL/s1600/spx+tr+vs+debt+to+cap+time+series.png" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" height="196" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgOjwLH47OAPrppwHwhy_ioHVUZlWxhDDxuYCQuNkOpWGvJZH_4-OiSwMPEkW8zPS1ZOFgKSXPuN8_STorES7Lnnop9ltXlMRdfrxdSS3A3M54PXPRu5AAHLW_es0FczbGkAfW1tuHIi6CL/s320/spx+tr+vs+debt+to+cap+time+series.png" width="320" /></a></div>
Earlier tonight, Matt Busigin <a href="https://twitter.com/mbusigin/status/410226991854411776">tweeted</a> a link to the series "<a href="http://research.stlouisfed.org/fred2/series/NCBCMDPMVCE">Credit Market Debt as a Percentage of the Market Value of Corporate Equities</a>" from the FRB's Z.1 report. After some back-and-forth with some other folks, Greg Merrill suggested that high debt to market cap looked like it it would correlate positively with forward returns. Intuitively, this works because, if we assume creditors are generally somewhat rational about underwriting standards, a sharp increase in Debt / Market Value would signify a sharp decrease in the value of equity from a level at which underwriters thought it was safe to lend. Stepping back, what we would be doing is measuring the "fair value" using debt as a proxy. <br />
<br />
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_tkS5gtkCatLPGyyT_8RAqfE3ZnosCpfgnX_W_4Bmdwpqj2m4NzeV6PcGVJ_RNrrG5i7_HqVtl0KE2L5VErKmi4FeF5q-Wlq2gkzLLy2uW6_rwo2uxqxkoTYnIGFi9hvB712XX2271rmq/s1600/spx+tr+vs+debt+to+cap+scatter.png" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" height="196" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_tkS5gtkCatLPGyyT_8RAqfE3ZnosCpfgnX_W_4Bmdwpqj2m4NzeV6PcGVJ_RNrrG5i7_HqVtl0KE2L5VErKmi4FeF5q-Wlq2gkzLLy2uW6_rwo2uxqxkoTYnIGFi9hvB712XX2271rmq/s320/spx+tr+vs+debt+to+cap+scatter.png" width="320" /></a>After thinking about it for a few seconds, I decided to plot our the series against annualized forward returns, shamelessly mining for the forward period that offered the best correlation. After starting with 5y (R=0.5985), 7y (R=0.7069), 10y (R=0.8411) and 11.5y (R=0.8677). After peaking at 11.5y (46 quarters) the correlation starts declining again. <br />
<br />
The actionable value of this exercise is questionable given the small sample size but, in my opinion, probably reflects the rational behavior of lenders and CFOs regarding debt levels. The average Debt / Market Value ratio for the sample is 57%, which is 9.1% higher that the latest (Q3) reading of 47.9%. Since the end of Q3 the Wilshire 5000 has risen 6.84%, representing a market-cap increase of $1,229 billion. We currently have no estimate for net corporate debt issuance since the end of Q3 but, if we extrapolate Q3's 2.2% increase, we get an estimate of a current 45.8% debt to market-cap ratio, which would correspond to a pretty average 7.8% annualized forward return for the next 11.5y. This expected return stands in sharp contrast to much lower expected returns obtained with similar methods by <a href="http://www.hussmanfunds.com/wmc/wmc131125.htm">John Hussman</a> using non-financial market cap as % of GDP and the Price/Sales ratio of the S&P 500 as predictors. I should note here that this expected return also lies significantly above my own 10y expected return of just 4.5%.<br />
<br />
Of course, the current Debt / Market Value lies in a particularly dense zone with significant dispersion, which--when combined with the 2.45% standard error of the linear regression--should give us pause as to the reliability of any such measure. In this particular casse, the expected total holding period is 132% and the -1 and +1 sd bands would lie at 82% and 207% respectively--not exactly a Swiss watch.Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com14tag:blogger.com,1999:blog-2262329415199130690.post-29147221488665594162013-12-05T06:02:00.000-05:002013-12-12T03:16:57.674-05:00Profit margins, tax receipts and labor demand curvesMuch has been made of the record levels of corporate tax profits over the last two years. From <a href="http://www.gmo.com/websitecontent/GMO_QtlyLetter_ALL_3Q2013.pdf">GMO's warnings</a> of an 1100 "fair price" for S&P 500, to <a href="http://www.hussmanfunds.com/wmc/wmc131125.htm">Hussman's forecast</a> of 10y of negative nominal returns, to the economics "It" girl of the moment, the <a href="http://philosophicaleconomics.wordpress.com/2013/11/24/cp/">Kalecky-Levy profits equation</a>. <a href="http://research.stlouisfed.org/fredgraph.png?g=pvQ">Real median household income</a>, in my opinion at a cyclical bottom, is back to early-to-mid 90s levels and as ZeroHedge (the best indicator of policy bear zeitgeist) reports, <a href="http://www.zerohedge.com/news/2013-12-04/wages-relative-profits-drop-all-time-low">wages are at an all-time low relative to profits</a>. Meanwhile, it seems like the entire Very Serious Old Guy complex is warning of mean reversion in a laundry list of ratio measures, but nobody wants to talk about whether it will be the nominator or denominator that will change. It is my intention to illustrate exactly how these measures will mean revert in a simple, common-sense way accessible to anyone with a cursory understanding of supply and demand curves and lay out what I expect to be a way to make investments guided by this thesis.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmmkSUe91q9qBzlctDf9M_R8EXB1cpZsYOtfGFkSD5V9vTJkkdmsvTLe_Vi8CZ0zo0moANJFCyvtB3lly_3fzu4VFK_ez5AWo-1KWnrFzRISSqZfig2fkFZD1_DmzNucW8nqfaMYOt4zRj/s1600/profits+taxes.png" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmmkSUe91q9qBzlctDf9M_R8EXB1cpZsYOtfGFkSD5V9vTJkkdmsvTLe_Vi8CZ0zo0moANJFCyvtB3lly_3fzu4VFK_ez5AWo-1KWnrFzRISSqZfig2fkFZD1_DmzNucW8nqfaMYOt4zRj/s1600/profits+taxes.png" height="192" width="320" /></a></div>
Corporate profits are high because effective tax rates are low, real wages are low, and debt to large companies is cheap, a point I've <a href="http://blog.morallybankrupt.org/2012/07/corporate-profit-margins-nothing-to-see.html">previously</a> made. They are about to start shrinking. When? Like right now. Maybe last month, or last quarter, even. What led me to write about this is, believe it or not, is public sector employment. Employees of State, Local and Federal governments are not many, <a href="http://research.stlouisfed.org/fred2/graph/?g=pvW">they peaked at 14.68% of the labor force</a> (not including the census high) exactly as private payrolls hit bottom, and hit a trough in June and July 2013 at 14.01% representing 21,826,000 employees. In other words, fiscal drag added 0.67% to the unemployment rate. <br />
<br />
But this summer we had three important developments: <br />
<ul>
</ul>
<ol>
<li>The <a href="http://research.stlouisfed.org/fred2/graph/?g=pvX">labor force</a> stopped growing</li>
<li>The number of <a href="http://research.stlouisfed.org/fred2/graph/?g=pvY">public sector employees</a> stopped shrinking and may be growing </li>
<li><a href="http://research.stlouisfed.org/fred2/graph/?g=pw0">Real average hourly earnings growth </a>of non-supervisory employees accelerated to a level coincident with the last expansion </li>
</ol>
<ul>
</ul>
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; text-align: right;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj65jLVvsA221eYVmiWy0nun-Vi4LFBzu1g9tgvG0BWIJv-bJKMQPb1UL2OLwNJeUvOhI2HHSKHvhfvYPg6luhplNOYanXVTJwNAu9QoBmhDZt7GLUywlL-kiHIctHrNV_1ZekEThAF39m3/s1600/gov+++pvt+emp+as+pct+of+labor+force.png" imageanchor="1" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj65jLVvsA221eYVmiWy0nun-Vi4LFBzu1g9tgvG0BWIJv-bJKMQPb1UL2OLwNJeUvOhI2HHSKHvhfvYPg6luhplNOYanXVTJwNAu9QoBmhDZt7GLUywlL-kiHIctHrNV_1ZekEThAF39m3/s1600/gov+++pvt+emp+as+pct+of+labor+force.png" height="192" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Public (blue rhs) and Private employment as % of labor force </td></tr>
</tbody></table>
In economic parlance, we can translate the first one as a change from a marginal pressure right on labor supply curve (curve inching slowly right as labor force grows) to curve shifting slowly left. Ceteris paribus, and assuming a downward slopped demand curve, the consequences would be an increase in the price of labor (coincident with #3) and a slight reduction in quantity demanded at the new price. The second would represent the public sector going from a marginal impulse left on the labor demand curve, to neutral or right maybe a slight force right, which will lead to stable or increasing price of labor (coincident with #3) and an increasing quantity of labor demanded at the new price. The third observation, present since Q1 of 2013, tells us that despite the public sector drag in the first half of 2013, private sector employment growth (demand curve shifting right) has been enough to lift average wages and increase the number of units of labor demanded at the higher price.<br />
<br />
With the private sector labor demand growing, public sector stable, or growing, and labor supply (labor force) stable or shrinking, the only plausible answer is wage growth. And, as the marginal unit of labor required to produce a marginal unit of final output goes up in price, so must marginal profit margins fall. But this is not the most interesting part.<br />
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; margin-left: 1em; text-align: right;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiDlMpa0VozvtwRgSo0Q7imuPQOFAi0PKd_tWhJgzS2v3A4w0xHpH2KTux7gTmWlzg8xfrCeJnXLkKsoSbcy1wt-QYwSrskFawEvdMSLY2yDw5K4WkGgqU4HlPzla4TeW7X4XRoRzKuEql2/s1600/capex+taxes.png" imageanchor="1" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiDlMpa0VozvtwRgSo0Q7imuPQOFAi0PKd_tWhJgzS2v3A4w0xHpH2KTux7gTmWlzg8xfrCeJnXLkKsoSbcy1wt-QYwSrskFawEvdMSLY2yDw5K4WkGgqU4HlPzla4TeW7X4XRoRzKuEql2/s1600/capex+taxes.png" height="192" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Capital expenditures / GDP (blue, lhs)<br />
After-tax profits / GDP (red, rhs)</td></tr>
</tbody></table>
The interesting part about the position we find ourselves in is that, because of the very low effective<a href="http://research.stlouisfed.org/fred2/graph/?g=pw5">corporate income tax rate</a> (~16.35% last year), and very low corporate investment rate, the marginal dollar earned by the corporate sector has very little impact on the economy, it just sits as retained earnings. Using <a href="http://research.stlouisfed.org/fred2/graph/?s[1][id]=NEWORDER">Manufacturers' New Orders: Nondefense Capital Goods</a> as a proxy for capital expenditure we can see that even though <a href="http://research.stlouisfed.org/fred2/graph/?g=pw9">corporate profits as a share of GDP have increased, capital expenditures as a share of GDP have decreased</a>, meaning the <i>marginal propensity to invest</i> in new capacity is low. This is because of depressed aggregate demand caused by the low labor share of income and previously mentioned low real wages.<br />
<br />
<br />
This, finally, gets me to my much delayed points:<br />
<ol>
<li>If the marginal effective tax rate of the household sector is higher than that of the corporate sector, which we know is true because <a href="http://en.wikipedia.org/wiki/Federal_Insurance_Contributions_Act_tax">FICA</a> on its own is 15.3% (split by employer and employee), a marginal dollar that moves from profits to wages will increase tax receipts</li>
<li>If the marginal propensity to consume of households is larger than the marginal propensity to invest of corporates, a marginal dollar that moves from profits to wages will increase aggregate demand</li>
<li>If the marginal propensity to consume or invest of the public sector is greater than the marginal propensity to invest of the corporate sector, the increase from #1 will increase aggregate demand</li>
<li><b>Any savings by households and/or government in excess of investment will be coincident with lower profits, all else equal.</b>*</li>
<li>Any increase in demand for labor by the public sector in response to #1 (in the form of bigger budgets) will be a marginal pressure to the right in labor demand which, all else equal, will lead to an increase in both the price and quantity demanded at the new price of labor. </li>
<li>Increases in employment and household income will reduce the cyclical deficit and reliance on government assistance programs like medicaid and "food stamps." This is, once again, an increase in government savings which is negative for profits. </li>
</ol>
I will stop here, as you are likely seeing the self-reinforcing cycle that will be triggered. Because <a href="http://en.wikipedia.org/wiki/File:Share_of_Federal_Revenue_from_Different_Tax_Sources_%28Individual,_Payroll,_and_Corporate%29_1950_-_2010.gif">payroll and individual income taxes</a> make up the lions share (~ 80%) of federal tax revenue, this will lead to a very strong self-feedback loop that will ultimately pressure corporate profit margins down and real wages up, reducing both the income and wealth distribution skew (the proverbial labor/capital divide) while redistributing corporate savings to the household and public sector.<br />
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; margin-left: 1em; text-align: right;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgjPpcPzCCZBzgoPbui1AW0Lak2mvSodYYybYAVJPvFUujrbwoe-G4ycqy3B1RVAI_7YK-gXfGt5OxWlTsCQkwENkt2gMBPIGk1BcSXUE7sCB9tVtv1p_9EFZKTggEi8aqlCdeWUAWVrDdu/s1600/real+rates+real+wages.png" imageanchor="1" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgjPpcPzCCZBzgoPbui1AW0Lak2mvSodYYybYAVJPvFUujrbwoe-G4ycqy3B1RVAI_7YK-gXfGt5OxWlTsCQkwENkt2gMBPIGk1BcSXUE7sCB9tVtv1p_9EFZKTggEi8aqlCdeWUAWVrDdu/s1600/real+rates+real+wages.png" height="192" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">10y treasury yield minus %YoY change in CPI (blue)<br />
%YoY change in average non-supervisory hourly wage<br />
minus %YoY change in CPI (red)</td></tr>
</tbody></table>
If the <a href="http://research.stlouisfed.org/fred2/graph/?g=pwg">past is any indication</a>, a real increase in wages will lead to higher nominal and real rates of interest for long term securities (thanks to <a href="https://twitter.com/mbusigin">Matt Busigin</a> for this one) which, if you recall earlier discussion, is one of the primary reasons for the elevated levels of profit margins. As liabilities mature and reprice at higher rates, this will be a direct hit to profit margins, especially so if the increase in the rate of financing is not only nominal but also real. Given the<a href="http://research.stlouisfed.org/fred2/graph/?g=pwh"> very low present financing rates</a> (without even mentioning qualitative measures like easy covenants) any future liability repricing is likely to increase the cost of capital and, once again, pressure profit margins. <br />
<br />
<div style="text-align: right;">
</div>
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEht2Fz9tG6fl5tdWt56stLS_AMO3URE1nxs3DvigbY7F-KTWRhFFxCWIh1pXoy-XEa04hUyrSJZ1KkcW77ntHNmMJIXJAZNZlbEXG4scNYTvJKsxz6qKPFsWBs9TaZWHKcsDnFWBIMStJNU/s1600/inv+as+pct+of+gdp+and+uer.png" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEht2Fz9tG6fl5tdWt56stLS_AMO3URE1nxs3DvigbY7F-KTWRhFFxCWIh1pXoy-XEa04hUyrSJZ1KkcW77ntHNmMJIXJAZNZlbEXG4scNYTvJKsxz6qKPFsWBs9TaZWHKcsDnFWBIMStJNU/s1600/inv+as+pct+of+gdp+and+uer.png" height="192" width="320" /></a></div>
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_hP36gNKg-WdWX8CsUNZYpKS_kQxdmFLjH8KfYrdDtofizqmPmxf0Utu3tFGFLHHcQ3V2JddnOE3-nksVFRF0YWRiWM2MQphxf1dbCS_5iDfKAHsppTWO-LzJLOg04NV2YixhLv5TwAEb/s1600/corp+as+pct+of+gdp+and+fwd+growth.png" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_hP36gNKg-WdWX8CsUNZYpKS_kQxdmFLjH8KfYrdDtofizqmPmxf0Utu3tFGFLHHcQ3V2JddnOE3-nksVFRF0YWRiWM2MQphxf1dbCS_5iDfKAHsppTWO-LzJLOg04NV2YixhLv5TwAEb/s1600/corp+as+pct+of+gdp+and+fwd+growth.png" height="192" width="320" /></a>Grantham, Hussman, Gross and many other investment managers have expressed concerns over elevated profit margins. To my knowledge, none of them have chosen to describe exactly how and why profit margins will fall and who will benefit and how. In this analysis, it is obvious that the beneficiaries of the sectoral rebalancing will be <i>wage-earning</i> households and tax receipts. The losers will be the <i>labor-intensive</i> employers, especially those that are highly leveraged because the cost of debt capital and cost of labor will rise at a speed greater than final demand or price inflation. It should also be clear by now the role of low investment (capital formation) and high unemployment (and associated cyclical deficits and low household savings rates) have had in the final sharp impulse upwards of corporate profits during a struggling economy and that, as labor markets recover, the household and government savings rate will gradually recover as corporate savings decline. Perhaps ironically, the same lack of investment that has helped prop-up corporate savings and holding unemployment high and kept inflation low will, as real wages increase, be the cause of any future increase in inflation. As, <a href="http://www.macrofugue.com/will-this-be-a-lost-decade-for-profits/">Matt Busigin has shown before</a> and you can see to the right, this analysis is not only <a href="http://www.macrofugue.com/unemployment-in-the-age-of-capital-abundance/">theoretically sound</a>, but also empirically true. <br />
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; margin-left: 1em; text-align: right;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-t2D3s1lydAUT5zQ-a7LUWPRZxmFSv0_1jsMhtb1TGezRiXS6f-7Nee8X4_HjvkzLBgey1D460aP_X5PHEE4uiedLecCVruObeBhFyHJuyh7vd9pnkhQvbe4xguit6pW-2r8bAXelILDR/s1600/net+investment+as+share+of+gdp.png" imageanchor="1" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-t2D3s1lydAUT5zQ-a7LUWPRZxmFSv0_1jsMhtb1TGezRiXS6f-7Nee8X4_HjvkzLBgey1D460aP_X5PHEE4uiedLecCVruObeBhFyHJuyh7vd9pnkhQvbe4xguit6pW-2r8bAXelILDR/s1600/net+investment+as+share+of+gdp.png" height="192" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Net Investment / GDP</td></tr>
</tbody></table>
This is likely to be very, very long cycle, even if it hits small cyclical snags along the way. Wages just started growing, the public sector just stopped being a drag on employment and <a href="http://research.stlouisfed.org/fred2/graph/?g=pAu">net investment just turned positive</a>. To anyone who missed the historic stock market rally, it may feel like it is too late, but this is just the beginning of the <i>real</i> economic recovery. It is also the beginning of inflationary pressures, but it will benefit wages more than prices. If you are wondering, "<i>what's the play?</i>" it is to favor being exposed to credit risk backed by public sector and household incomes and avoid being exposed to credit risk being backed by corporate incomes, especially those that are labor-intensive or highly indebted. Because the Federal government is considered a credit-risk free entity, this would mean the credit risk of state and local governments (which are ultimately backed by incomes of the residents) and of households, either directly through securitized obligations or indirectly through institutions that have a large exposure to households as creditors. Using extreme examples, you would want to own a company that insures mortgages and consumer ABS securitizations as well as municipal bonds, and avoid the lower tranches of any recent vintage CLO. <br />
<br />
Is this a doomsday sign for stocks? Maybe not. It is possible that aggregate demand growth is enough to let profits fall as GDP increases and profits rise more slowly, however, it is not likely in my opinion. Assuming a reversal to mid 2000s effective corporate tax rates of 22% after tax profits as % of GNP to a generous 7% (median is 6.10% and mean is 6.34%) and a NGNP growth rate of 6% (mean 6.11%, median 6.7%, current 3%) over 10 years the CAGR of after-tax corporate profits would not amount to more than 1.65%. But it is also not terrible. GMO likes to flaunt their 1100 "fair value" number and Hussman is partial to his price-to-sales ratio chart, but there is no reason for stocks to fall to their fair value, and every day that passes, their fair value will close in to their present value, and at an accelerating pace. This would make selling short equity a trade with a short lifespan, while other trades--especially those where time works in your favor, like <a href="http://blog.morallybankrupt.org/2013/07/muni-madness-redux.html">being long high-grade municipal bonds,</a> an asset class which happens to be <a href="http://www.slideshare.net/GuillermoRoditiDomin/new-river-investments-tax-exempt-commentary">offering remarkable value</a>--offer much more attractive ways to play the thesis.<br />
<br />
<b>Shorter version</b><br />
Marginal head-winds for employment and wages are turning into marginal tail winds as the economy recovers. These same factors posses self-reinforcing properties and are likely to continue to be positive impulses for, real wages, employment levels, tax receipts, and aggregate demand and negative impulses for corporate profit margins and corporate savings. Favor the liabilities of the household and public sector over those of the corporate sector.<br />
<br />
<br />
<span style="font-size: x-small;"><i>*Going back to Kalecki's Profit equation we can remember that:</i></span><br />
<br />
<span style="font-size: x-small;"><i>Corporate Saving = Profits - Dividends </i></span><br />
<span style="font-size: x-small;"><i>Profits = Investment – Household Savings – Government Savings – Foreign Savings + Dividends</i></span>Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com28tag:blogger.com,1999:blog-2262329415199130690.post-47171658502444095652013-11-26T23:30:00.000-05:002013-11-26T23:57:43.478-05:00Social Advertising Economics<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgjGuXAAknuOtWVy8v6tOSJ9Iy0kegUXUr4lGAdbSgCFkPnTUiBotY1oZGHbZrKR_B1Bdr2KEgXed35hE9AYum5hVvDkCgXYtqgriYkJz8aE8oqaw-QUDjZ02tDIGHtaNvnFB_CbjTXL3hy/s1600/yahoo+ads+prices.png" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgjGuXAAknuOtWVy8v6tOSJ9Iy0kegUXUr4lGAdbSgCFkPnTUiBotY1oZGHbZrKR_B1Bdr2KEgXed35hE9AYum5hVvDkCgXYtqgriYkJz8aE8oqaw-QUDjZ02tDIGHtaNvnFB_CbjTXL3hy/s1600/yahoo+ads+prices.png" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">YoY ad pricing from Yahoo!'s <a href="http://finance.zenfs.com/assets/gf/q3_2013_earnings/Q313_Earnings_Presentation.pdf">3Q2013 presentation</a></td></tr>
</tbody></table>
Like Facebook before them, new "social" web properties eventually have to monetize to and generate revenue. As properties seek to monetize their user base through the use of display or per-click ads, the amount of ad space being sold will increase. In economics parlance, what we would be seeing as mature high-traffic web properties seek to monetize with advertising is the advertising supply curve shift right, increasing the quantity supplied at a lower price point (ceteris paribus). Of course, one tiny website can't really move the curve, but when Facebook, Yelp, Twitter, Tumblr, and now Instagram, are all pushing to monetize their traffic--large sites with <i>lots</i> of traffic and <i>lots </i>of growth--it matters.<br />
<br />
What this means, in simpler terms, is that as long as the change in web/mobile traffic * the change in density of ads (ads displayed per user/visit/pageview, whatever) increases (S right) faster than the natural growth of advertising budgets * the change in share that web commands vs traditional (D right), the price of ads will fall. Judging by the double digit pageview growth rates and double digit revenue growth targets in most of these names, as well as addition of new entrants as more maturing services start monetizing, it looks a lot to me like advertising space, especially display ads, will see increasing price pressures down and, in my opinion, the market will segment into highly-targeted ads to a small sliver of the users that will command a high but shrinking premium, and the rest, which will be a margin-destroying race to the bottom. If you don't believe me, look at Yahoo!'s YoY change in ads price and ads sold and see if you can pinpoint when Facebook went public. Their price trends have deteriorated while their volume was improved, or rather their volume has improved because their prices have declined.<br />
<br />
I think it's very likely that in the next 12 months we will find out what the price elasticity of demand for web advertising is and--particularly for display ads--I think it will be a lot more likely to surprise to the downside.Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com68tag:blogger.com,1999:blog-2262329415199130690.post-7058155919375813092013-10-29T00:31:00.001-04:002013-11-03T17:29:49.656-05:00How Much is $1 of Earnings Worth?Investors often treat reported earnings as the "yield" of equities due to the wide availability of reported earnings and the ubiquitous Price-to-Earnings ratio, however this can be a misleading measure of the actual economic value created for shareholders if earnings are overstated during cyclical upturns and the subsequent adjustment during downturns is reported as one-time items or direct-to-equity adjustments. I propose an alternate measure, a sum of the change in reported book value and dividends paid out as a proxy for the economic value created in a period.<br />
<br />
Over the last 22 years, every $1 of S&P500 reported earnings has only led to $0.76 of dividends + book-value gains. If you exclude 2008, the year in which reported earnings and the alternate measure previously described differ most, every $1.00 of earnings generates only about $0.84 of economic value to investors. The sample, admittedly limited in size, was obtained using Bloomberg. Bold red line indicates a slope of 1, lighter black line is a simple OLS regression trend-line with no intercept.<br />
<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijutGZ_n_2W9pWgHyYAT-65LTVo5dvb0tlqKQBLcxEsESo4wvC4UHNauTkQhSAUVl1EhH3tKpviGc8m-lpWaOvdXIrpm1vvxhho4JED26dYYnIr5slGsuENUtXJN0Z7AiCp8-Aw4tLJEAr/s1600/earnings+and+returns.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijutGZ_n_2W9pWgHyYAT-65LTVo5dvb0tlqKQBLcxEsESo4wvC4UHNauTkQhSAUVl1EhH3tKpviGc8m-lpWaOvdXIrpm1vvxhho4JED26dYYnIr5slGsuENUtXJN0Z7AiCp8-Aw4tLJEAr/s1600/earnings+and+returns.PNG" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Change in BV + dividends vs reported earnings</td></tr>
</tbody></table>
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjL_UhV2UvwKBbLRSLDdr7z3pNxmCZWnhvj3iOZfCqEbHUDDJbFdEzxEe87uQZKNfBmH1R739OxfZOc2HAnNEE6eiDoGifkvdmzXnyStKoIzIxFsAtHpID4uWUSRGZ6QfrKSUPUdxKzihEY/s1600/earnings+and+returns+ex+2008.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjL_UhV2UvwKBbLRSLDdr7z3pNxmCZWnhvj3iOZfCqEbHUDDJbFdEzxEe87uQZKNfBmH1R739OxfZOc2HAnNEE6eiDoGifkvdmzXnyStKoIzIxFsAtHpID4uWUSRGZ6QfrKSUPUdxKzihEY/s1600/earnings+and+returns+ex+2008.PNG" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Change in BV + dividends vs reported earnings ex-2008</td></tr>
</tbody></table>
<b>EDIT: </b>A reader helpfully pointed out that I left-out the effect of buy-backs, which accrue to the price of shares but are functionally equivalent to dividends. Lacking a time-series of total buy backs, I can't correct the post to include that. Additionally, any buy-back made at a P/B multiple of > 1 would dilute BV per share. Assuming book value is understated is a reasonable assumption for companies where marginal investment turns out to be profitable or during inflationary periods where the nominal value of capital stock is understated as a result. My apologies for these careless omissions. I will not remove the post, but I think it is worth noting that these omissions make the prior analysis basically useless.Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com25tag:blogger.com,1999:blog-2262329415199130690.post-14342756394794497532013-10-12T16:32:00.000-04:002013-10-12T16:32:06.072-04:00The short-term car rental service of the future<!--[if gte mso 9]><xml>
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<![endif]-->In the <a href="http://blog.morallybankrupt.org/2013/10/mobile-computing-and-future-of.html">previous post</a>, I wrote about how I envision smartphones replacing many of the functions of in-car entertainment and navigation systems. In this post I will be focusing on how that can affect automobile ownership and culture. <br /><br />One of the small features that really blew my mind when I purchased my car was proximity-based keys which allow you to enter and start your car without having to ever put a key inside a lock. Not only that, but each key stores all sorts of preferences, from mirror and seat positioning and suspension settings, allowing each key holder to customize their driving experience. While I welcome this marginal innovation, it leads me to ask, “Why do we even need keys?” With the introduction of <a href="http://en.wikipedia.org/wiki/Near_field_communication">NFC</a> and <a href="http://en.wikipedia.org/wiki/IBeacon">like-technologies</a> into our smartphones, there’s no reason why keys can’t be replaced with our smartphones, the same ones which can then be docked into the car to load your personalized settings. Turning the automobile into a “thin-client” of sorts would allow any car to be your car, introducing a whole new opportunity set for the future of automobile rentals. <br /><br />A couple of weeks ago I was in Paris for a couple of days. Having limited time and wanting to see as much of the city as possible during my short stay, I opted for renting a bike (velib) and riding around the city. One of the things that caught my eye as I tried to navigate roundabouts and punished my coccyx on cobblestoned streets was the presence of an electric car sharing system called <a href="http://en.wikipedia.org/wiki/Autolib%27">Autolib</a>. While it may not be suitable for many Americans, the success of Zipcar in dense, urban, locations is proof that there is a market for short-term car rental within close proximity to people’s homes. Improving this model by using electric cars with inductive-charging capabilities and reserved docking parking spots located throughout the city, eliminating the need to return the car to the same point of origin would remove some of the final inconveniences. <br /><br />Imagine basic compact, inexpensive and utilitarian automobiles parked every couple of blocks. If you are a service subscriber, you simply walk-up to the car, use the NFC-capability of your phone to unlock it, and dock your phone on the dash to double as a navigation/entertainment display. The unique identifier of the car is recorded by the phone and submitted to a central database, and if your account is in good standing, a one-time use key is digitally delivered to your phone which allows the car to start. Your phone’s built-in navigation system includes all the car rental locations and availability of both cars and spaces is updated in real-time. A parking-assist function (much easier to implement in fully-electric cars) helps keeps dings to a minimum and internal diagnostic checks are run and uploaded at the time of docking the automobile, allowing the rental operator to easily keep track of maintenance needs and fleet location. Because your identity is linked to your phone and entry / ignition are recorded and associated to you, there is a strong disincentive to vandalize or abuse the cars, and no need to worry about someone breaking-in to steal a stereo--you’re carrying it out. <br /><br />The uses for this range from short local round trips to places inaccessible by transit, to one-way trips for those nights when you may want to feel free to indulge in a few cocktails with dinner and not have to worry about driving home at the end of the night. Additionally, reducing the cost of not driving your own car out may lead to reductions in drink-driving, an additional positive externality. The logistic challenges are not trivial, but they are not great and all of the technologies listed in this post are already available today, it’s just a matter of someone putting it all together.Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com165tag:blogger.com,1999:blog-2262329415199130690.post-76195089719291781292013-10-12T16:26:00.001-04:002013-10-12T16:26:45.993-04:00Mobile computing and the future of the automobile<!--[if gte mso 9]><xml>
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</xml><![endif]-->I'm deviating from my usual focus on capital markets here to share some early thoughts on what I believe to be the future of the automobile industry.<br /><br />Recently, after a decade of not owning an automobile, I purchased a car. The car comes with an in-dash entertainment/navigation system that would have likely blown my mind ten years ago but today, despite it being an award-winning top-of-the-line system, it feels nothing short of antiquated. I find myself constantly thinking, “<i>My phone would be better at this.</i>” The problem, in my opinion, is the mismatch between mechanical and computing life cycles. The median age of the American automobile fleet is 11.2 years <a href="http://www.reuters.com/article/2013/08/06/us-autos-age-polk-idUSBRE97503V20130806">according to consulting firm Polk</a>. In a computing time-table, 11 years is an eternity. To put it in context, the first generation iPhone was released only 5 years ago, in June 2007. In that short span of time we’ve seen cellular data technology transition from GPRS/G2 to 3G to 4G to 4G LTE which represents an increase from ~<a href="http://www.engadget.com/2011/01/17/2g-3g-4g-and-everything-in-between-an-engadget-wireless-prim/">150kbps</a> effective speeds for non-EDGE 2G to <a href="http://bgr.com/2013/06/17/4g-lte-speeds-att-verizon-sprint-t-mobile/">11-16mbps</a> on the newer 4G LTE networks. In the last 4 years alone, mobile phone bandwidth has increased by a factor of 6 and screen resolution has doubled and we’ve seen the introduction of what is probably the most advanced voice-recognition technology available to the mobile consumer. <br /><br />How is this relevant? Except for functions that are unlikely to change much in coming years like speakerphone capabilities or digital audio playback, the technologies at the center of modern in-car computers like data connectivity, A-GPS-aided navigation and voice recognition are evolving more rapidly than the replacement cycle of automobiles, leading to cars which have useful lives multiple times longer than the technology at the center of the user interface. Which brings us to the question; does the automobile really need an embedded computer? <br />
<br />As smart-phones become ubiquitous and the computing power available in them grows exponentially, it makes sense to allow our smartphones to become our on-board entertainment and navigation systems. Just like the embedded car-phone gave way to Bluetooth hands-free technology and trunk-loaded CD changers were replaced by mini jacks and Bluetooth audio, so will data connectivity and navigation / entertainment systems. It simply makes no sense to embed wireless connectivity circuitry that will be woefully out-of-date in 3 years to a machine expected to last 15 years or more. It artificially severely limits the useful life span of an automobile and non-luxury producers will soon adapt as they see the opportunity to reduce costs while touting it as an advantage for the type of consumer that can’t afford to replace a car every 3 or 4 years.<br />
<br />Once products like <a href="http://www.ubuntu.com/phone">Ubuntu EDGE</a> become a reality, there will be no need for auto manufacturers to include on-board entertainment computers anymore. Cars will feature a “dock” (wired initially, but eventually transitioning to wireless and featuring <a href="http://en.wikipedia.org/wiki/Inductive_charging">inductive-charging</a>) and the necessary peripherals (microphone, displays, speakers, physical controls, if any). Your handset already has your music, your phone book, your address book, voice recognition, data-connectivity and A-GPS capabilities. Most importantly, your handset can (and does for many of us) back-up wirelessly and constantly to the cloud, ensuring that replacing our smartphone is as easy as buying and activating a new device and ensuring the possibility of massive data loss is minimal and the pain of transferring information to a new car (for example, a rental) is painless.Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com84tag:blogger.com,1999:blog-2262329415199130690.post-78349280059560746152013-07-26T04:51:00.001-04:002013-07-26T04:51:22.973-04:00Muni Madness (redux)<div style="text-align: center;">
<i>If you follow me on twitter, you've seen this and can probably skip it.</i> </div>
<br />
In what seems like a yearly event now, with 3 consecutive years of this game, tax-exempt municipal bonds are once again cheap. It could be the overall bond sell-off, it could be the Detroit scandal, it could be bond fund outflows; I don't know what the cause is, but I do know the bonds are cheap.<br />
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Frequent readers know we are generally fans of quantitative methods, so expect some numbers.<br />
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In the last 5 years, our preferred proxy for the tax-exempt AAA market has disconnected itself the ratio range that was common until the global financial crisis. Due to the tax-exempt nature of muni bonds, benchmark yields were often quoted as a percentage of treasury yields instead of a spread, but this has become an increasingly inaccurate way to look at yields. We consider two options:<br />
<ol>
<li>The market underwent a structural change by which the old measures became invalid. An example of a similar event would be the '87 crash after which options began exhibiting (steeper) volatility smiles. In this case we would consider the structural change to be either a transition from rate-based to an credit-based market, a change in the way liquidity is priced post-GFC or a combination of the two.</li>
<li>That the "fair-value" ratio is itself a function of interest rates and tax-exempt bonds exhibit negative convexity as yields approach a floor, a relationship which had not been visible until the introduction of ZIRP brought treasury yields down far enough for the relationship top be visible.</li>
</ol>
Although we agree with the assertions that, market-wide, the tax-exempt market has transitioned from rate to credit, we believe the AAA benchmark is exempt from this because of its information insensitive nature (for more on this see <a href="http://www.frbatlanta.org/news/conferen/09fmc/gorton.pdf">Slapped in the Face by the Invisible Hand</a> by Gary Gorton) and while we generally agree about the repricing of liquidity post-GFC, we believe we have the ability to control for that (more later). A review of the data from 2001 to present day as well as our expectation of behavior by participants makes us believe the second option, that the "fair" ratio is dynamic, is the likely explanation.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdG-JSkcUZt5oFXeMTRzzv9DCR58xk4X8yuZFuFkSQVpTcTA8XLd0uFwFLG41Ml6Bf_X26uwUzlBkY__yI1XQIj2RYx-lM_tZgoyV2T92OgkkJ77JUPeMR8Mybe5eQfxNpcGsNMLzuxvs-/s1600/mma+ratio+vs+ust+10y.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="300" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdG-JSkcUZt5oFXeMTRzzv9DCR58xk4X8yuZFuFkSQVpTcTA8XLd0uFwFLG41Ml6Bf_X26uwUzlBkY__yI1XQIj2RYx-lM_tZgoyV2T92OgkkJ77JUPeMR8Mybe5eQfxNpcGsNMLzuxvs-/s400/mma+ratio+vs+ust+10y.png" width="400" /></a></div>
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Although we do not put much weight on the automatically generated regression, we believe it to suffice as evidence that tax-exempt bonds tend to exhibit negative convexity, possibly from an absolute rate floor. Below you can observe 2001-present and June 2009-present time series with accompanying overlaid histograms showing ratio changes over time and the distribution of values within those time periods. Please notice the increase in ratios as yields fell to new lows as the adoption of forward guidance and quantitative policy by the Fed lowered 10y rates to new post-WWII lows and the apparent reversion of this trend after the secular low was printed in June 2012.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj7Dohoa48aGqmxJacAXFB3gqAPT5JizUxe2iOGDTPFWdBuckwZEHIBZM-kE9HN_hJO3cvndCe6ltaLmq9N_Qucx9bJW0bqcwvf2Wu0IixjQmZOqqAfi_ZpWZ0UgxVoJQamZ5UnWf7lJ2Lg/s1600/mma+ratio+and+dist+2001-2013.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="240" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj7Dohoa48aGqmxJacAXFB3gqAPT5JizUxe2iOGDTPFWdBuckwZEHIBZM-kE9HN_hJO3cvndCe6ltaLmq9N_Qucx9bJW0bqcwvf2Wu0IixjQmZOqqAfi_ZpWZ0UgxVoJQamZ5UnWf7lJ2Lg/s400/mma+ratio+and+dist+2001-2013.png" width="400" /></a></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi0waZMOtu0kvkqDs0D5-ZlzGfdsn-liSLTeNrq_jaBc9l3otndWgwcpbg57jWSyiGS8LULykNmmFRP06LBINO_mTgg_XP0MyOYdlaOIiiJtOeMeVf242UJGszNI1HaAz-wXU2z_joe8REM/s1600/mma+ratio+and+dist+2009-2013.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="240" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi0waZMOtu0kvkqDs0D5-ZlzGfdsn-liSLTeNrq_jaBc9l3otndWgwcpbg57jWSyiGS8LULykNmmFRP06LBINO_mTgg_XP0MyOYdlaOIiiJtOeMeVf242UJGszNI1HaAz-wXU2z_joe8REM/s400/mma+ratio+and+dist+2009-2013.png" width="400" /></a></div>
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Continuing this general line of thinking, we explore a linear relationship between the AAA 10y tax-exempt yield and the 10y treasury yield and find strong evidence of a nearly constant sensitivity of municipal yields to treasury yields of 0.587. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1K9IAbjmD-UgI91R2P-P30bOwIon-IoKCl3y4DcFtWQomT7vp5-EdUN1QaW27ZHmaNwn0-9F-slUb1yyM8y-Dx_zGggIQYlsPjK8GV7R6cg4YOn9_Nk77_Yj5RpVmsL2NxqoDChzDe80R/s1600/mma10y-ust10y+scatter.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="297" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1K9IAbjmD-UgI91R2P-P30bOwIon-IoKCl3y4DcFtWQomT7vp5-EdUN1QaW27ZHmaNwn0-9F-slUb1yyM8y-Dx_zGggIQYlsPjK8GV7R6cg4YOn9_Nk77_Yj5RpVmsL2NxqoDChzDe80R/s400/mma10y-ust10y+scatter.png" width="400" /> </a></div>
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We expand this simple example into a multiple regression incorporating the MOVE index and the VIX index as a measure of treasury-implied volatility and a proxy for CDX.IG respectively. This allows us to internalize other credit-insensitive spread products into the model, namely MBS (for more information read about MBS replication) and high-grade corporate bonds. </div>
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To test for structural changes pre- and post GFC-, we slice the data into 4 time periods:</div>
<ul>
<li><b>pre-GFC: </b> prior to January 1st, 2008</li>
<li><b>GFC</b>: January 1st, 2008 - June 1st, 2009</li>
<li><b>post-GFC</b>: subsequent to June 1st, 2009</li>
<li><b>Complete:</b> all data </li>
</ul>
The results are reproduced below:<br />
<br />
<b>PRE-CRISIS DATA
</b><br />
<pre> </pre>
<pre>Residuals:
Min 1Q Median 3Q Max
-0.260117 -0.066022 -0.004478 0.067822 0.227960
Coefficients:
Estimate Std. Error t value Pr(>|t|)
(Intercept) 0.8584473 0.0255899 33.55 <2e-16 ***
pre_crisis_data$USGG10YR 0.6018459 0.0049374 121.89 <2e-16 ***
pre_crisis_data$MOVE 0.0019368 0.0001343 14.42 <2e-16 ***
pre_crisis_data$VIX 0.0064424 0.0004559 14.13 <2e-16 ***
---
Signif. codes: 0 ‘***’ 0.001 ‘**’ 0.01 ‘*’ 0.05 ‘.’ 0.1 ‘ ’ 1
Residual standard error: 0.09118 on 1719 degrees of freedom
Multiple R-squared: 0.9001, Adjusted R-squared: 0.9
F-statistic: 5165 on 3 and 1719 DF, p-value: < 2.2e-16
</pre>
<b>CRISIS DATA:
</b><br />
<pre>
Residuals:
Min 1Q Median 3Q Max
-0.66890 -0.17289 0.05204 0.15769 0.59407
Coefficients:
Estimate Std. Error t value Pr(>|t|)
(Intercept) 1.770108 0.113410 15.608 <2e-16 ***
crisis_data$USGG10YR 0.294021 0.027904 10.537 <2e-16 ***
crisis_data$MOVE 0.005621 0.000594 9.462 <2e-16 ***
crisis_data$VIX 0.003370 0.001531 2.201 0.0284 *
---
Signif. codes: 0 ‘***’ 0.001 ‘**’ 0.01 ‘*’ 0.05 ‘.’ 0.1 ‘ ’ 1
Residual standard error: 0.2308 on 349 degrees of freedom
Multiple R-squared: 0.517, Adjusted R-squared: 0.5128
Residuals:
Min 1Q Median 3Q Max
-0.30228 -0.08212 -0.00518 0.06629 0.47018 </pre>
<pre> </pre>
<b>POST CRISIS DATA:</b>
<br />
<pre> </pre>
<pre>Coefficients:
Estimate Std. Error t value Pr(>|t|)
(Intercept) 0.981564 0.016827 58.331 <2e-16 ***
post_crisis_data$USGG10YR 0.519255 0.006456 80.426 <2e-16 ***
post_crisis_data$MOVE 0.002171 0.000249 8.718 <2e-16 ***
post_crisis_data$VIX 0.006691 0.000766 8.735 <2e-16 ***
---
Signif. codes: 0 ‘***’ 0.001 ‘**’ 0.01 ‘*’ 0.05 ‘.’ 0.1 ‘ ’ 1
Residual standard error: 0.1195 on 1034 degrees of freedom
Multiple R-squared: 0.9322, Adjusted R-squared: 0.932
F-statistic: 4736 on 3 and 1034 DF, p-value: < 2.2e-16
F-statistic: 124.5 on 3 and 349 DF, p-value: < 2.2e-16</pre>
<pre> </pre>
<b>COMPLETE SAMPLE:</b>
<br />
<pre> </pre>
<pre>Residuals:
Min 1Q Median 3Q Max
-0.43382 -0.06802 -0.00074 0.07707 0.38103
Coefficients:
Estimate Std. Error t value Pr(>|t|)
(Intercept) 0.8175504 0.0107706 75.91 <2e-16 ***
all_data$USGG10YR 0.6160607 0.0021784 282.81 <2e-16 ***
all_data$MOVE 0.0014400 0.0001251 11.51 <2e-16 ***
all_data$VIX 0.0068161 0.0004370 15.60 <2e-16 ***
---
Signif. codes: 0 ‘***’ 0.001 ‘**’ 0.01 ‘*’ 0.05 ‘.’ 0.1 ‘ ’ 1
Residual standard error: 0.1128 on 2757 degrees of freedom
Multiple R-squared: 0.9726, Adjusted R-squared: 0.9726
F-statistic: 3.268e+04 on 3 and 2757 DF, p-value: < 2.2e-16
</pre>
<br />
As you can see, outside the GFC-period, all of the variables are statistically significant, and the models exhibit high R^2s. Although there is mild colinearity between VIX and MOVE, the correlation is limited and the results are not invalidated. A test for heteroskadicity reveals no significant skerodasticity outside the November, 2008 credit meltdown.<br />
<br />
The following table displays the correlation matrix between the residuals of various estimation methods:<br />
<br />
<pre> all pre-gfc post-gfc non-gfc
all 1.0000000 0.9957032 0.8588698 1.0000000
pre-gfc 0.9957032 1.0000000 0.8949263 0.9957032
post-gfc 0.8588698 0.8949263 1.0000000 0.8588698
non-gfc 1.0000000 0.9957032 0.8588698 1.0000000 </pre>
<pre> </pre>
Based on the very high correlations as well as a review of the residual time series, we don't believe there was a significant structural change after the GFC and believe the benefits of using a strictly post-GFC distribution are outweighed by the lower sample size. For the following illustrations, we use the model regressed from the full sample. A higher residual value represents a lower than predicted yield for the MMA 10y benchmark and a lower value represents a "cheaper" MMA 10y. The first chart illustrates the last year, where the "basis" is the residual of the regression, in percentage points. The second is a time series of residuals over the entire sample.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjzPfg1viyeqFRhpsukNFijM9VPV8b9NE-eSiMipeAGL24fjhlMBvUhkS2anyuJAFAc5KLHDFYyDm0hdtcdU9a3zXtRwFqQmG9RmY2FvYPKK_5lHvTy-JObbbSJcSbhocdN1VTLKihtBvYi/s1600/muni+model+2013-07-25.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="195" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjzPfg1viyeqFRhpsukNFijM9VPV8b9NE-eSiMipeAGL24fjhlMBvUhkS2anyuJAFAc5KLHDFYyDm0hdtcdU9a3zXtRwFqQmG9RmY2FvYPKK_5lHvTy-JObbbSJcSbhocdN1VTLKihtBvYi/s400/muni+model+2013-07-25.png" width="400" /></a></div>
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTYtAwdwJf0gk5rSFDpgimCs_mLgvfnweDUVnWJ6M-FFeiwJ57Hid0oeD1lLEti3KrGMcQMqhOqu3SwImVIARMw-sp70QG045BLDw3CPFNVHiXziZO2ZN38_zvfWEpilBQPP_fjccaS8S8/s1600/muni+model+his+basis.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="236" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTYtAwdwJf0gk5rSFDpgimCs_mLgvfnweDUVnWJ6M-FFeiwJ57Hid0oeD1lLEti3KrGMcQMqhOqu3SwImVIARMw-sp70QG045BLDw3CPFNVHiXziZO2ZN38_zvfWEpilBQPP_fjccaS8S8/s400/muni+model+his+basis.png" width="400" /></a></div>
<h3>
<b>Conclusion</b></h3>
We think high-grade tax-exempt bonds are cheap. The yields we are seeing right now are usually associated with higher rate and/or higher volatility periods. Additionally, given the apparent turn in interest rates, we see the lower rate-sensitivity and accompanying negative convexity as fundamentally attractive features in a rising-rate environment. The loss in "upside" from the negative-convexity is more than compensated, in our opinion, by higher pre- and post-tax yields, and there remains significant price-upside if yields normalize to predicted levels in a sideways-rates market. We believe ample liquidity and accomodative monetary policy limits the risks of a 2008-like tail scenario, despite what a certain blonde talking-head (who, incidentally, triggered the last sell-off of a similar magnitude in early 2011) with no P&L to speak-of may be saying on TV. Depending on how much zerohedge you read, your mileage may vary.<br />
<br />
Tomorrow we will attempt to revisit the topic from a different angle, comparing tax-exempt credit to corporate credit to illustrate the difference in priced-in losses and then, sometime this weekend, we hope to touch on some vehicles the average investor can use to express a view on the sector.<br />
<br />
xoxo,<br />
<br />
groditiAnonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com3tag:blogger.com,1999:blog-2262329415199130690.post-26179076019503068822013-05-13T19:11:00.001-04:002013-05-13T19:11:57.739-04:00Housekeeping noteMy last 3 longer pieces have all been posted at Kevin Ferry's excellent site, The Contrarian Corner. It is likely that most of my more serious posts will be published there in the future. You can find all my contributions to it at the following address:<br />
<a href="http://thecontrariancorner.com/?author=88911"><br /></a>
<a href="http://thecontrariancorner.com/?author=88911">The Contrarian Corner - Author Archives - groditi</a><br />
<br />
The last 3 pieces have been:<br />
<ul>
<li><a href="http://thecontrariancorner.com/?p=7557">Too much money, not enough paper, redux</a> </li>
<li><a href="http://thecontrariancorner.com/?p=9432">How Leveraged Money Becomes Less Leveraged (and less money)</a> </li>
<li><a href="http://thecontrariancorner.com/?p=9740">The Low Return of High Yield</a></li>
</ul>
<h1 class="entry-title">
</h1>
Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com6tag:blogger.com,1999:blog-2262329415199130690.post-30729312702692548472012-11-11T22:36:00.002-05:002012-11-11T22:36:49.427-05:00ARSUSD Blue Chip Swap Rate (BCS)<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9fWmpmIWX4xMpScMoHCLuyrP5bWVV1WG-W5eewNsZV6_UAJkYgwer7iIx8yjE3g8Py5FzP8CtavJeEvLFjslhp3e0WK2Odin20u_jasRh1bKxU1N69I9roWKqJ-GaN6fJf7M-M6tR1ms8/s1600/blue+chip+swap+rate.png" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" height="302" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi9fWmpmIWX4xMpScMoHCLuyrP5bWVV1WG-W5eewNsZV6_UAJkYgwer7iIx8yjE3g8Py5FzP8CtavJeEvLFjslhp3e0WK2Odin20u_jasRh1bKxU1N69I9roWKqJ-GaN6fJf7M-M6tR1ms8/s400/blue+chip+swap+rate.png" width="400" /></a></div>
Quick post since I've been approached multiple times in the last few weeks about the calculation of the Blue Chip Swap Rate (BCS), a popular unofficial measure of the market-driven price of ARSUSD (NDFs settle against the official ARSUSD cross, which is tightly controlled by the central bank). As you can see, the current BCS for USDARS is ~6.86 vs the official rate at 4.77, representing a large premium on USDs by the Argentine population. With inflation persisting and Banco Central de la Republica Argentina (BCRA) keeping peso depreciation under the rate of actual inflation (and equal to the official inflation measure) the Argentine peso becomes more overvalued every day that passes, making exports increasingly uncompetitive in the global markets (reducing supply of USDs by reducing the current account balance), depressing the local economy and <a href="http://www.bloomberg.com/news/2012-08-17/argentine-capital-flight-rose-after-dollar-purchases-limited.html">exacerbating capital flight</a> despite a <a href="http://blogs.ft.com/beyond-brics/tag/capital-controls/">plethora of capital controls</a> introduced over the last 14 months. The most likely ending for this situation is a sudden and violent devaluation similar to the <a href="http://en.wikipedia.org/wiki/1994_economic_crisis_in_Mexico">Mexican devaluation of December 1994</a> once BCRA loses its grip on the exchange rate.<br />
<br />
OtherRelated Readings:<br />
<a href="http://en.mercopress.com/2012/08/31/argentina-surprised-by-germany-which-voted-against-granting-a-loan-at-the-idb">Argentina surprised by Germany, which voted against granting a loan at the IDB</a><br /><a href="http://blogs.ft.com/beyond-brics/2012/10/09/argentine-bonds-fall-on-selective-default">Argentine bonds fall following “selective default”</a><br />
<a href="http://www.bloomberg.com/video/argentina-demands-1-for-1-on-imports-exports-a3dCz8zxTamOUbWiP~PNeQ.html/">Argentina demands 1-for-1 on imports/exports (video)</a>Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com2tag:blogger.com,1999:blog-2262329415199130690.post-58950608851688859592012-11-02T13:16:00.000-04:002012-11-02T13:16:27.219-04:00Marginal purchases will continue until real term structure steepens<div style="text-align: center;">
<i>Note: for those unfamiliar with terminology of TIPS, please see <a href="http://blog.morallybankrupt.org/2012/09/give-me-break-even.html">Give me a Break (even)</a> for some basic discussion</i></div>
<div style="text-align: center;">
<i> </i></div>
<a href="https://twitter.com/groditi/status/264396062389858305">Last night</a>, I finally came up with a concise way of expressing my Fed policy view: "<i>Marginal purchases will continue until real term structure steepens.</i>"<br />
<br />
Real term structure flattening means that "<a href="http://blog.morallybankrupt.org/2012/10/too-much-money-not-enough-paper.html">too much money, not enough paper</a>" is still valid, and marginal Fed LSAPs are reducing the supply of available financial assets enough to lower rates by increasing supply of reserves and reducing supply of risk-free assets. Bear steepening of the real term structure would mean that either marginal asset-buyers have decided other assets offer better prospective returns (flight-to-safety has ended), private credit is growing at a faster pace than the Fed is reducing supply of assets (deleveraging has ended) or, more likely, a combination of both. A side effect of rising and steepening real rates would be that the discount rate (ex-effect from break-evens) used to discount future private cash-flows would rise and therefore, all else equal, that would mean lower asset prices across the board for cash-flow generating assets. I use the real term-structure for this mental exercise because expected returns of non-risk free assets are affected by inflation expectations both in variable-rate instruments (loans, FRNs, some ABS, equities) through rate expectations and fixed-rate instruments as well through expected default rates and recovery expectations. Not to worry, though, falling asset prices due to higher real rates are an eventual inevitability of the Fed's exceptionally accommodating monetary policy and must be accepted as such. All it will mean is buying the same assets at higher expected returns, and should be welcome news for anyone with more financial assets than liabilities.Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com0tag:blogger.com,1999:blog-2262329415199130690.post-90397873531232069072012-10-18T10:26:00.002-04:002012-10-18T10:26:59.761-04:00Too much money, not enough paperIf you follow me on <a href="http://twitter.com/groditi">twitter</a>, you are by now very well acquainted with the title of this post. What it refers to is the fact that the Fed's LSAPs are creating a surplus of liquidity and scarcity of product in capital markets, which has driven prices up in any financial asset that generates yield (and many that don't). During this yield chase--or, as I like to call it, The Great Incredible Paper Chase--debt issuers have done what any rational party would have done when there is more demand than supply of a good they can produce, they've stepped up production. As long as the Fed is expanding their balance sheet, the market will have the capacity to absorb new issuance, but it is important to remember that the Fed's balance sheet expansion will not continue forever and that, at some point, they will halt expansion and/or mop-up reserves. At that point, if the issuance of new paper and the capacity of the market to absorb it are in equilibrium, the equilibrium will be upset and, like anyone who has taken an economics 101 course can tell you, prices will reflect it.<br />
<br />
So, before getting into a fist-fight over the last tootsie roll left in the mud after the yield piñata, remember that the eventual draining of reserves by the Fed will have full-size snickers raining from the skies and no amount of tootsie rolls will be a fair trade for even a bite-sized milky way.<br />
<br />
<br />Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com2tag:blogger.com,1999:blog-2262329415199130690.post-41736643154425022732012-09-28T12:58:00.000-04:002012-09-28T12:58:07.552-04:00Y u hate capital so much?!The following text was originally posted as a <a href="http://www.economicmusings.com/post/21411639444/how-spain-pays-the-piper">comment</a> to <a href="http://www.economicmusings.com/post/21411639444/how-spain-pays-the-piper">David Schawel</a>'s Economic Musings blog on April 19th, but it seems relevant to bring it back given <a href="http://www.bde.es/bde/es/secciones/prensa/infointeres/reestructuracion/">the freebase scenario</a> making the rounds. My official position is that it's going to be an adverse reality unless we stop hating capital. It's a little off-the-cuff so don't get caught up in precision and just try to to suck up the main point, which is, <i><b>without new capital, the banks are decimating the private sector in order to fund the deficit (aka support the government)</b></i> AKA NO BUENO<br />
<br />
From "<a href="http://www.economicmusings.com/post/21411639444/how-spain-pays-the-piper">How Spain pays the piper</a>",<br />
<div class="post-message publisher-anchor-color " data-role="message">
<blockquote class="tr_bq">
Given
that we are starting with a capital-constrained banking system (even
before write-downs or 2013 EBA recommendations), we know this, holding
capital levels stable, any government deficit must be matched by foreign
capital or by reduced lending to the private sector to maintain
leverage ratios stable--of course, due to 0%-RW on SPGBs, the EUR amt
need not match centavo for centavo. Now, retained earnings (new capital)
are not zero, so banks can either maintain their balance sheet size
and increase their capital ratio (delever), or increase balance sheet
size (fund the deficit) and maintain their capital ratio, or--most
likely--something in between, where purchases of new sovereign bonds
against increases in capital and levered via LTRO produce large amounts
of carry.<br />
This gives us the illusion that banks may very well be able to earn
their way out of this mess (see also: LTRO), however, this all changes
if we change the risk weight on SPGBs to something other than its
current level of zero. Which is were we ask ourselves: In a country
where almost 3/4 of private household wealth (ex expected benefits from
government pensions, etc) is held as housing equity which has been
borrowed against, what happens to the sovereign if that # is cut in
half? After all, the sovereign's creditworthiness is just the aggregate
of the households. Its credit backed by its ability to tax and/or
confiscate private wealth to pay back creditors. If the households are,
collectively, broke, then what is left for the government to take? Which
is where I--finally--get to my point. If the government represents the
collective households and the collective households are overburdened,
then<b> how will they be able to back their sovereign's increasing promises
as the banks decimate the private sector through loan attrition?</b> Or,
in simpler terms, Is there any difference between
extending-and-pretending with the households' mortgages and
extending-and-pretending with the sovereign's obligations? <br />
As we continue on our march to binary outcomes, I believe it becomes
important to ask ourselves, why do we hate capital so much? What is so
wrong about recapitalizing the banks and arresting this self-feedback
loop? Is it about crystallizing losses by raising equity at prices below
book? If so, why the big deal? If equity were really so under-priced,
current shareholders would surely rush to a private offering before
letting outsiders dilute them, no?<br />
As a final comment, I think there is a 4th possible solution: Capital injections from the core banks and sovereigns.<br />Maybe
this should actually be 3c, but given that we know there is no way
except for "more capital" to resolve this and whether it be through
debt-to-equity swaps or lower than normal real rates, Core private
savings will ultimately pay for this. It might be nice to skip the whole
near-financial-meltdown part that ends in core households
recapitalizing their own banks after the D2E swaps and just get it over
with so 25% of the worlds 12th largest economy could, you know, get back
to work.</blockquote>
</div>
Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com2tag:blogger.com,1999:blog-2262329415199130690.post-77013120794179095422012-09-21T15:50:00.000-04:002012-09-21T15:59:13.838-04:00A tale of two spreads (laughing all the way to the bank)<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="clear: left; float: left; margin-bottom: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjG0NUE87IGfRUz0DmZxAH7nQrHqpMpWyY2RlveW9yO9B4vfuKLaOEhntP7E99KkZhsB3A1JIHyXdLxR5t7NRaJXSIZfyJ0_F0141kkoKJttbqg6JgyKDYacBKRt45wCQDGOKTg7gGXR9TO/s1600/tale+of+two+spreads.PNG" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="168" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjG0NUE87IGfRUz0DmZxAH7nQrHqpMpWyY2RlveW9yO9B4vfuKLaOEhntP7E99KkZhsB3A1JIHyXdLxR5t7NRaJXSIZfyJ0_F0141kkoKJttbqg6JgyKDYacBKRt45wCQDGOKTg7gGXR9TO/s320/tale+of+two+spreads.PNG" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">top: spread between mortgage rates and MBS yield<br />
bottom: spread between CC MBS and 7-year US treasury note</td></tr>
</tbody></table>
On the heels of the Fed announcing it's latest round of LSAPs, we are suddenly seeing a flurry of media attention around the fact that, despite rocketing MBS prices, mortgage rates are simply not budging. Of course, regular readers are not surprised, as on September 9th I highlighted this very likely possibility in, <a href="http://blog.morallybankrupt.org/2012/09/the-twist-redux.html">The twist (redux)</a>, A point that David Schawel <a href="http://www.economicmusings.com/post/28878650167/harp-tbtf-banks-laughing-all-the-way-home">originally brought up</a>
on August 6th (and whose post title I shamelessly stole). <br />
<blockquote class="tr_bq" style="clear: both;">
...there is evidence to doubt whether lower MBS spreads will be passed on to customers or whether the banks will <a href="http://www.economicmusings.com/post/28878650167/harp-tbtf-banks-laughing-all-the-way-home">keep the windfall</a>.
Despite current coupons trading at record tight spreads, the
"primary-secondary" spread remains, not only stubbornly high, but near
all-time record highs! Proponents of the MBS Twist
insist that the Fed can put pressure on the "primary-secondary" spread
and push savings to borrowers by increasing (more in a second) their
purchases of current coupons, but to me it is clear that the problem
lies in the demand, not supply, side of loans. This is why, unless we
see further expansion of <a href="http://en.wikipedia.org/wiki/Home_Affordable_Refinance_Program">H.A.R.P.</a>
(Home Affordable Refinance Program) which increases the pool of
homeowners eligible for refinance, I think the ultimate effect of an
"MBS Twist" on aggregate demand will be limited and the ultimate
economic beneficiaries will be banks and security holders who see their
securities increase in price. </blockquote>
Since
Chairman Bernanke announced the latest round of open-ended LSAPs,
current-coupon MBS has tightened 56bp to Treasuries while the
primary-secondary spread widened 31bp to all-time record highs despite
7y Treasury notes trading 10bp wider than pre-FOMC. Meanwhile, earlier
today, <a href="https://twitter.com/DavidSchawel/status/249201611967193088/photo/1/large">MBS traded flat to 10y swaps</a>. It is clear who's keeping the windfall for now.<br />
<div class="separator" style="clear: both; text-align: center;">
</div>
Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com19tag:blogger.com,1999:blog-2262329415199130690.post-78130289675499766022012-09-15T20:54:00.000-04:002012-09-15T20:55:47.636-04:00Give me a break (even)<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKaZr6H4dNqiotW1kSCSuV3_uzuhJZo-XJh78_H2Sto8Ow7OrO2btRe6btQfMHPJgysUFHciaSVy9iukN_Z8QGKbVRzb6dyx59tx3Gxtd8aEpMIP4MW2rsTzy-p8ITzEcmX0yDw5rCKyan/s1600/tips-nominals-breakevens.gif" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="229" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKaZr6H4dNqiotW1kSCSuV3_uzuhJZo-XJh78_H2Sto8Ow7OrO2btRe6btQfMHPJgysUFHciaSVy9iukN_Z8QGKbVRzb6dyx59tx3Gxtd8aEpMIP4MW2rsTzy-p8ITzEcmX0yDw5rCKyan/s320/tips-nominals-breakevens.gif" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Top: TIPS & UST curves; Bottom: break-evens </td></tr>
</tbody></table>
Some market participants have described the mechanism through which quantitative monetary policy (read: LSAPs) works or is intended to work to be centered around inflation expectations. The line of thinking is that the Fed is trying to stoke inflation expectations to incentivise purchase of goods today by increasing the rate at which people expect the price level to increase while holding down rates, increasing the gap between yields and expectations of inflation, commonly referred to as the "real rate" and observed in the market for Treasury Inflation Protected Securities (TIPS).<br />
<br />
From the TIPS and US Treasury Notes and Bonds curves we can derive what we call "break-evens," or the level of future inflation at which payoffs of both TIPS and regular Treasuries are the same. There's some idiosyncrasies here because there is optionality in TIPS as and a right skew to inflation, and so it is possible (and in my opinion true) that this option is reflected in yields and TIPS holders are willing to pay an additional premium (which is constantly changing) for the embedded option which is ultimately reflected in break-evens, which are often interpreted as "inflation expectations."<br />
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4-Fn5V_Rrp04vLgSfDj9p6kCtNCAB1opOVMHBowa8bradNCw8VYP5omJ6mYm39KIWpizcQSxMUyzg3fN_rgBef8yKmAz0TIRyV7yMXc0tlPaL_b3GHsqPFpUUsXzAOAECypUuKCbM8tNA/s1600/breakevens.gif" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="229" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4-Fn5V_Rrp04vLgSfDj9p6kCtNCAB1opOVMHBowa8bradNCw8VYP5omJ6mYm39KIWpizcQSxMUyzg3fN_rgBef8yKmAz0TIRyV7yMXc0tlPaL_b3GHsqPFpUUsXzAOAECypUuKCbM8tNA/s320/breakevens.gif" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">5-year, 10-year, and 5-year forward 5-year break-evens (rhs)<br />
YoY All Urban Consumers CPI (lhs)</td></tr>
</tbody></table>
<div style="text-align: left;">
</div>
It is hard to ignore the sudden rise in break-evens coinciding with anticipation for Fed LSAPs (QE), and I am choosing to interpret this reaction as representative of market participant "animal spirits." The sudden rise in break-evens (71bp for 5y!!) means that a level of inflation above the Fed's symmetrical target is now "priced-in" for US Treasuries. Which leaves us with the question, "Will incremental asset purchases by the Fed increase the compounded annual rate of inflation by 0.70% over the next five years?" My opinion is that they will not and break-evens are showing us that there is either panic over what additional LSAPs mean for near-term inflation or there the option embedded in TIPS is being aggressively bought and the rise in break-evens reflects the rising premium of this hypothetical call option. <br />
<br />
With both core and headline YoY CPI comparisons below the 2% symmetrical target, core YoY CPI displaying a negative 1st derivative and YoY comparisons getting easier (CPI rate of change peaked last year around August) it looks to me like break-evens are excessively ebullient given the evidence of quantitative policy effects on the general price level over the last 3+ years in the US. It is my belief that quantitative monetary policy alone during a period of deleveraging can not generate the necessary credit growth to drive meaningful price inflation other than through whatever transitory effect a weaker currency has on commodity inputs (which represent a small % of final price). As I mentioned in <a href="http://blog.morallybankrupt.org/2012/09/the-twist-redux.html">The Twist, redux</a>,<br />
<blockquote class="tr_bq">
While borrowers continue to deleverage, any impact from lower rates
will be limited and <i>as mortgage debt outstanding continues to fall, the
marginal stimulative power of monetary policy, unfortunately,
diminishes.</i><br />
<br />
Additionally,there is evidence to doubt whether lower MBS spreads will be passed on to customers or whether the banks will <a href="http://www.economicmusings.com/post/28878650167/harp-tbtf-banks-laughing-all-the-way-home">keep the windfall</a>.
Despite current coupons trading at record tight spreads, the
"primary-secondary" spread remains, not only stubbornly high, but near
all-time record highs! (see lower left). ... This is why, unless we
see further expansion of <a href="http://en.wikipedia.org/wiki/Home_Affordable_Refinance_Program">H.A.R.P.</a>
(Home Affordable Refinance Program) which increases the pool of
homeowners eligible for refinance, I think the ultimate effect of an
"MBS Twist" on aggregate demand will be limited and the ultimate
economic beneficiaries will be banks and security holders who see their
securities increase in price. </blockquote>
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjo5f7HgjOVpogCNpiQZcqOYXLYof66wZQiRAk1ZYiIjg_QPtYKXI-A-WVnUztlOEFgXqIukUQ6aaui2tixylvkz4xEguvrcLki0qh3-bY9mG66ebzOsN55_ZIZIulU2wEAHMZ4VxFeXIa3/s1600/weekly-hourly+earnings.png" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="192" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjo5f7HgjOVpogCNpiQZcqOYXLYof66wZQiRAk1ZYiIjg_QPtYKXI-A-WVnUztlOEFgXqIukUQ6aaui2tixylvkz4xEguvrcLki0qh3-bY9mG66ebzOsN55_ZIZIulU2wEAHMZ4VxFeXIa3/s320/weekly-hourly+earnings.png" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">YoY % change in average hourly and weekly earnings<br />
of private sector employees. (<a href="http://research.stlouisfed.org/fred2/graph/?g=aJ9">source</a>)</td></tr>
</tbody></table>
That is why, unless the Fed's continuing LSAPs are paired with fiscal stimulus (hopefully in the form of an extension of the HARP program) I have a hard time believing current break-evens will be achieved. Additionally, I have chosen to interpret the Fed FOMC's decision to embark in another round of LSAPs as confirmation the economy remains fragile and the growth outlook has not improved and, with gasoline prices flirting with $5/gal, and real wages still falling, it is hard to see how marginal purchases of mortgage securities (that have marginally diminishing impact) will manage to stoke aggregate demand to a level that drives meaningful inflation in the short term. Keeping mortgage rates low provides an increase in discretionary income for homeowners able to refinance at a lower rate but, if real wages don't grow and <a href="http://research.stlouisfed.org/fred2/graph/?g=aJc">gasoline price increases</a> are taking a significant portion of those savings, the beneficiaries are basically just treading water. And, if I had to guess, I would guess that a non-trivial portion of savings from any mortgage refinancing will go towards paying down revolving credit.<br />
<br />
That's why, against every piece of folksy advice<span style="background-color: white; color: #666666; font-size: x-small;">*</span> I've gotten from veteran traders, I am very much bullish on the 10-year Treasury Note. I bought exposure to this tenor because I think, in no uncertain terms, that inflation expectations have a harsh reality check coming, the embedded call in TIPS is grossly overpriced and--due to their healthy roll, favorable 2s10s steepness and high exposure to inflation expectations--the ten year note is the ideal way to play this thesis. As such, I will continue to buy weakness in the note and concentrate my duration exposure around this particular tenor. The market has become entirely too intoxicated with the promises of QE and has forgotten that monetary base expansion is not inflationary without both credit and wage growth. <br />
<br />
The you go, that is my thesis for buying dimes. In the words of my friend <a href="http://www.thecontrariancorner.com/">Kevin Ferry</a>, "<i>book it, time-stamp it, laminate it, decoupage it, roll it up and smoke it!</i>"<br />
<br />
<span style="font-size: x-small;"><span style="color: #cccccc;"><span style="color: #999999;">* "Don't fight the Fed," "Don't fight the tape," "Don't get married to a position," "There's old traders and bold trades but no old bold traders"</span></span></span>Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com14tag:blogger.com,1999:blog-2262329415199130690.post-42144163408499391552012-09-13T16:11:00.000-04:002012-09-13T16:11:31.049-04:00Shorter Monetary Policy<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqKsNFZx9i_ea47RCLV5GaL9WdynCZhdea9nDFtfJkEzFerBXTPNAhlF0s_4m1wi8SiNGdd5B1omLfk6ZNAUGi7sEpMaOnsI7-4XaZyn60Mzl9CgU0-o271fF16kzg8NfLyzbR-JB_JOPK/s1600/3qw8j6.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="239" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqKsNFZx9i_ea47RCLV5GaL9WdynCZhdea9nDFtfJkEzFerBXTPNAhlF0s_4m1wi8SiNGdd5B1omLfk6ZNAUGi7sEpMaOnsI7-4XaZyn60Mzl9CgU0-o271fF16kzg8NfLyzbR-JB_JOPK/s320/3qw8j6.jpg" width="320" /></a></div>
<br />Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com14tag:blogger.com,1999:blog-2262329415199130690.post-74797948804082904152012-09-09T20:06:00.001-04:002012-09-09T20:06:50.048-04:00Home prices and interest ratesWith mortgage rates near record lows, due both to low inflation and negative real rates, the leveraged purchasing power of real wages is near historic maximums. Additionally, for the most part, it looks like the bottom is in for housing price declines. Does this make it a good time to buy leveraged real-estate to capture future price appreciation while financing it at low rates? I do not think it's as clear as many people think it is. Below we'll explore why.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; margin-left: 1em; text-align: right;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjx5SCUy4hYNXhTmYmrNLW_wOPlBgkaWwE7oRWmTwmBGvvRKEp0DHL9vNYWjl_ladzqb7ZeIi6Nwjwkdip2SpkCK2nIWLj_9MxT9lQ3hza_zBPzyqOsGyqoToINLhPA32rO4k4BvjKJ1nja/s1600/purchasing+power+of+payment.PNG" imageanchor="1" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="208" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjx5SCUy4hYNXhTmYmrNLW_wOPlBgkaWwE7oRWmTwmBGvvRKEp0DHL9vNYWjl_ladzqb7ZeIi6Nwjwkdip2SpkCK2nIWLj_9MxT9lQ3hza_zBPzyqOsGyqoToINLhPA32rO4k4BvjKJ1nja/s320/purchasing+power+of+payment.PNG" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Purchasing power of a $1,000 monthly payment on a <br />
30-year fixed-rate mortgage assuming 15% down-payment.</td></tr>
</tbody></table>
The purchasing power of a fixed monthly payment is dependent on two things, the number of periods, and the interest rate. If we maintain the the number of payments constant and put interest rates on the <i>x </i>axis and purchasing power on the <i>y</i> axis, you can see how purchasing power declines at a declining rate as rates increasing. In other words, it is an inverse exponential function, the first derivative of purchasing power with respect to rates is negative while the second derivative is positive.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
</div>
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgK72KrjXhFDUBTT97jwOECHKuh2wjRFjUZSsyUjCYahy1ecjrHWFICI1phkebw-Bd_WNcFExy20A_6y37eAmCRXfPUokEw3PxDZ29cdYCkq6O055quBWiNnPqnUU2LQEh0Gt9_rg7Cy4Rj/s1600/secondary+spread.gif" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="229" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgK72KrjXhFDUBTT97jwOECHKuh2wjRFjUZSsyUjCYahy1ecjrHWFICI1phkebw-Bd_WNcFExy20A_6y37eAmCRXfPUokEw3PxDZ29cdYCkq6O055quBWiNnPqnUU2LQEh0Gt9_rg7Cy4Rj/s320/secondary+spread.gif" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">"primary-secondary" spread</td></tr>
</tbody></table>
To keep this exercise simple, we will consider the interest rate on a mortgage to be a function of a risk-free rate and a spread. For the sake of simplicity we will consider this spread as compensation the lender receives for taking-on various risks and duties (credit and prepayment risks as well as compensate the the servicer of the loan). The two accompanying screenshots illustrate the "primary-secondary" spread, or the spread between mortgage rates and the yield on mortgage-backed securities, and the spread between the yield of a 30-year current coupon MBS and the 10-year US Treasury Note. The sum of these two spreads roughly represents the aggregate spread between risk-free rates and the national average average mortgage rate. <br />
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg32bEcVgKxmWLWQjfxsPW8TDrdGO4PoKb56o2FBw4MI8Zf8Bsd3BCXRyrUxjc5TGdBOzi5i_IebBFVotmQu1Y4Q-3BWfAHjQxes_zJiLLgj1GMBWcrd-8QxWs53Ssih3X62v407tEFseyd/s1600/fnma+cc+vs+10s.gif" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="228" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg32bEcVgKxmWLWQjfxsPW8TDrdGO4PoKb56o2FBw4MI8Zf8Bsd3BCXRyrUxjc5TGdBOzi5i_IebBFVotmQu1Y4Q-3BWfAHjQxes_zJiLLgj1GMBWcrd-8QxWs53Ssih3X62v407tEFseyd/s320/fnma+cc+vs+10s.gif" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fannie Mae current coupon, 10-year US Treasury Note spread</td></tr>
</tbody></table>
As<a href="http://blog.morallybankrupt.org/2012/09/the-twist-redux.html"> previously discussed</a>, this is one of the main channels in which the Fed has been supporting the property market. By lowering the Fed funds target and through LSAPs (Large Scale Asset Purchases, colloquially known as QE or Quantitative Easing) they increased the purchasing power of payments by lowering the spread of MBS trade at to treasuries and lowered interest rates. Later on, by buying US Treasury notes and bonds, in what is sometimes called QE2, they lowered interest rates. And, finally, with 2011s "Operation Twist," they helped flatten the yield curve and bring down longer-term interest rates. By buying Treasuries and Agency MBS, the Fed pushed underlying risk-free rates down and and helped put downward pressure on the spread by pushing down the value of the embedded option in the securities (lowering implied volatility of the embedded option).<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjhYF03TzpSIjVZ0t7kM4NMmerYfd9isv6nyzkcVMqP3QlrGICqh0JzPyYjOUn3BxW8rkPAW48nCMRV0eN8urGR-H4uKH0vZCFRoEZqGK5NrC3FsTiyWlaRgabq5NbBmeQvuaZsJZpDqHkU/s1600/reals+&+breakevens.gif" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" height="229" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjhYF03TzpSIjVZ0t7kM4NMmerYfd9isv6nyzkcVMqP3QlrGICqh0JzPyYjOUn3BxW8rkPAW48nCMRV0eN8urGR-H4uKH0vZCFRoEZqGK5NrC3FsTiyWlaRgabq5NbBmeQvuaZsJZpDqHkU/s320/reals+&+breakevens.gif" width="320" /></a></div>
Finally, we need to recognize that the risk-free rate is also a function of two factors, the real rate of interest and future inflation expectations. The real rate of interest + inflation expectations equal the nominal rate of interest. We can observe the real rate of interest through Treasury Inflation Protected Securities (TIPS) and can compute inflation expectations by comparing that to the yield on regular treasuries, this is called the break-even rate. Therefore we now see that the purchasing power of a monthly payment is dependent on the mortgage spread, the level of real rates, and the market's expectation of future inflation. <br />
<br />
You're probably thinking, "<i>gee, thanks for the lesson, but what does this have to do with home prices?</i>" Well, everything. As you can see from the charts above, both the spread on MBS and the level of real rates (how much return lenders expect to earn after inflation) are both at historical lows and the primary-secondary spread is refusing to fall despite record-tight spreads to treasuries. Increases in either real rates or MBS spreads would, unless accompanied by falling inflation expectations or lower primary-secondary spread, cause a fall in purchasing power. In fact, an increase from present mortgage rates of just 0.50% would lower the purchasing power of a payment by almost 6%!<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjnK6QTjoUSHixX_n4uyRFGBbu8S4kBQeVCSeFI8urlvnDTo4zPEwg2hXY4XgbwkP6tP3zvsuHJPnNup7_3Wy7h-pfaMDjTwK0C3AIHGqGSKXa_1j7JCBeqaFEfloP0QHaeexjhAR0Yzd2p/s1600/pmt+as+pct+of+median+household+income.PNG" imageanchor="1" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><br /></a></div>
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; margin-left: 1em; text-align: right;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiAphDWlTCHazwrRx1DgO4JsZXhn6aKPQUJ7qT1XrRNg2Z-cQD77YI5gC-0H17mf1jSjWq48EO4O08b9Be9Efo2mIT0pDSafBlsFMlEHEjwSIiX1v7s3HYFXHm_pTiFsPNZAP18PQTCmkOx/s1600/pmt+as+pct+of+median+household+income.PNG" imageanchor="1" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="206" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiAphDWlTCHazwrRx1DgO4JsZXhn6aKPQUJ7qT1XrRNg2Z-cQD77YI5gC-0H17mf1jSjWq48EO4O08b9Be9Efo2mIT0pDSafBlsFMlEHEjwSIiX1v7s3HYFXHm_pTiFsPNZAP18PQTCmkOx/s320/pmt+as+pct+of+median+household+income.PNG" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Historical % of median household income required to buy<br /> a median-price existing home at prevailing mortgage rates</td><td class="tr-caption" style="text-align: center;"><br /></td></tr>
</tbody></table>
Until now we have worked through this exercise assuming the payment is fixed but, historically, we find that home prices tend to roughly follow wages. As you can see from the chart to the right, the payment required to buy a median price existing-home using the national average of mortgage rates mostly oscillates between 25% and 35% of median household income (mean is 30%). In other words, housing prices are constrained by purchasing, which is a function of wages and and interest rates. Which, finally, leads me to the reason I do not believe increases in home prices are as sure a bet as many think.<br />
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; margin-left: 1em; text-align: right;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNby-DMu8j9_hDV7RcEQ19gKLKggDDMlOwjktXFEVgdhLeg45B85kCKF8Gg1BScBXR4oRU83hQjdBcTMbdJ7EY1M8Z-DiDF2XiSBqD6wFtsW1enGx40zx7JwT24vMzbsYLtFMjVnVY3-9h/s1600/purchasing+power+as+pmt+changes.PNG" imageanchor="1" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="187" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNby-DMu8j9_hDV7RcEQ19gKLKggDDMlOwjktXFEVgdhLeg45B85kCKF8Gg1BScBXR4oRU83hQjdBcTMbdJ7EY1M8Z-DiDF2XiSBqD6wFtsW1enGx40zx7JwT24vMzbsYLtFMjVnVY3-9h/s320/purchasing+power+as+pmt+changes.PNG" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Purchasing power of various payments at a 3.5% interest rate</td></tr>
</tbody></table>
For home prices to sustainably exceed inflation, wage gains have to outpace inflation by more than the increase in rates over that same time period. We saw in the first chart that purchasing power <i>increases at an increasing rate</i> as rates decline. Here, we can see that see that, at a fixed interest rate, purchasing power increases <i>at a stable rate</i> with payment. This means that for home prices to sustainably increase, growth in wages not only has to outpace inflation, but it has to outpace it by a margin wide enough to compensate for losses in purchasing power from any changes in the mortgage rate during that same period.<br />
<br />
The Federal reserve is taking extraordinary actions to keep interest rates, risk-spreads and implied volatility low in order to stimulate the economy and achieve their 2% inflation-rate target. Remember Chairman Bernanke publicly stated, <i>"[the 2 percent target is] not a ceiling, it’s a symmetric objective." </i>While this leaves the door open for future easing in the near-term, we need to remember that, at some point, the easing cycle will stop and drop in real rates will stop, even if it seems unthinkable now. <br />
<br />
My good friend <a href="http://www.economicmusings.com/">David Schawel</a> and I like to joke around that the Fed was nice enough to allow us to recognize all the future income of our bonds early. And, in a way, this is exactly what the Fed is trying to achieve with housing. By inflating purchasing power through lower real rates and compressed spreads, the Fed has allowed home-owners to recognize the future appreciation of their property at an accelerated pace. In the future, as real growth returns and, with it, real rates rise, the purchasing power of a payment will drop and rising home prices will require either households to devote a larger % of household income to housing and/or wages to increase at a rate faster than inflation. Remember, a 0.5% increase in mortgage rates from current levels would reduce purchasing power by about 5.94% if we maintained payment unchanged. At the same time, the increase in payment for a stable loan price if rates rose 0.50% would be 6.32%. In other words, to maintain prices stable, monthly outlays need to increase at a faster rate than pricing power decreases due to any change in rate moves. <br />
<br />
Depressed real estate prices and low financing rates are leading many to see the current climate as a golden opportunity to buy leveraged real-estate, but price increases are not guaranteed, and the pay-out on a leveraged bet on housing is dependent many different factors. While affordability remains high and payments as % of income are near historic lows due to the Fed's extremely accommodating policy, an economic recovery can put an end to Fed accommodation and suspension of the Fed's MBS reinvestment program would be reflected on both, the risk-free interest rate and the spread at which MBS trade, turning a tailwind into a headwind for price appreciation. Leveraged buyers also run the risk of near-term price declines or inflation rates below the rate priced in by nominal rates. Leveraged real estate requires price appreciation and/or profits from rents to outpace the rate of inflation built-in to interest rates, which as we already saw, is <i>not</i> near lows. <br />
<br />
I don't have an opinion on whether residential real-estate is a good or bad investment, it's not my line of work, but I think many investors are failing to see that a leveraged bet on real-estate price appreciation is, indirectly, a bet on inflation exceeding current inflation expectations and future wages increasing at a rate faster than inflation. <i>Under an inflationary environment, increases in the real price level of real estate would require a mix of an increase in the % of income spent on housing and real wages in order to allow growth in outlays to outpace the loss in purchasing power created by any increase in real-rates, inflation expectations, or mortgage spreads.</i><br />
<br />Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com193tag:blogger.com,1999:blog-2262329415199130690.post-47539430308060218192012-09-09T18:56:00.000-04:002012-09-09T18:56:57.072-04:00The twist, redux<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: right; margin-left: 1em; text-align: right;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQp-L9KSLa63n4KOW9NysNLaw1-13fGjhzzy-ZOINznbVRHzLF3u67FNDUxOaZjBU04GNI8xmJ7V2zWfvx7r5MEai35Ir6HHTPFoXEn8ELTeoxnmd-p-0rtCAzXloJ2lyouKOPMztfGtYu/s1600/fnma+cc+vs+10s.gif" imageanchor="1" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="229" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQp-L9KSLa63n4KOW9NysNLaw1-13fGjhzzy-ZOINznbVRHzLF3u67FNDUxOaZjBU04GNI8xmJ7V2zWfvx7r5MEai35Ir6HHTPFoXEn8ELTeoxnmd-p-0rtCAzXloJ2lyouKOPMztfGtYu/s320/fnma+cc+vs+10s.gif" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Fannie Mae current coupon minus 10-year US Treasury note</td></tr>
</tbody></table>
Much has been written about the possibility of further Large Scale Asset Purchases (LSAPs, or QE) by the Fed. One of the main points of focus has been speculation about where those, if any, additional purchases will take place. One of the more probable, in my opinion, options is what has been called the "MBS Twist" by various analysts and strategists, including Harley Bassman of Credit Suisse. The "MBS Twist,"--a reference to the decision by the Fed to transact monetary policy by changing the maturity structure of its holdings, originally in 1961, and most recently in August 2011--would be a balance-sheet neutral operation in which the Fed sells MBS holdings with higher coupons to buy so-called "current coupon" (trading closest to, but not exceeding par) MBS. This would mean selling bonds in which the embedded short call-option is in-the-money to buy bonds where the embedded option is at-the-money and longer-dated. This should, in theory, reduce the market clearing price of the embedded option which would be seen as a compression of implied volatility in the market. The idea behind this action is to compress the spread of current-coupon Agency MBS over treasuries (pictured right) and hope the compression in spread is eventually passed on to borrowers in the form of lower yields to incentivize home purchases or loan refinancing. <br />
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjx5SCUy4hYNXhTmYmrNLW_wOPlBgkaWwE7oRWmTwmBGvvRKEp0DHL9vNYWjl_ladzqb7ZeIi6Nwjwkdip2SpkCK2nIWLj_9MxT9lQ3hza_zBPzyqOsGyqoToINLhPA32rO4k4BvjKJ1nja/s1600/purchasing+power+of+payment.PNG" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="208" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjx5SCUy4hYNXhTmYmrNLW_wOPlBgkaWwE7oRWmTwmBGvvRKEp0DHL9vNYWjl_ladzqb7ZeIi6Nwjwkdip2SpkCK2nIWLj_9MxT9lQ3hza_zBPzyqOsGyqoToINLhPA32rO4k4BvjKJ1nja/s320/purchasing+power+of+payment.PNG" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Purchasing power of a $1,000 payment at various interest rates</td></tr>
</tbody></table>
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicuIoBEwrg2x7uNheLd54JYKeo93tEHCz58hks2j2E5s6_dd5X7eMmCleHaRPB0dE1dxdtQAo-346GpqqB_iQ9du36WmiZCyDNCLCf0RQMGNULtafsOx8isTjU0vja0UtjdoINN4idi9G6/s1600/mortgage+debt+outstanding.png" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="192" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicuIoBEwrg2x7uNheLd54JYKeo93tEHCz58hks2j2E5s6_dd5X7eMmCleHaRPB0dE1dxdtQAo-346GpqqB_iQ9du36WmiZCyDNCLCf0RQMGNULtafsOx8isTjU0vja0UtjdoINN4idi9G6/s320/mortgage+debt+outstanding.png" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Mortgage debt outstanding (<a href="https://research.stlouisfed.org/fred2/graph/?s[1][id]=HHMSDODNS">source</a>)</td></tr>
</tbody></table>
In theory, this is a pretty clever plan. Lower rates increase the purchasing power of a monthly payment exponentially (illustrated left). This helps support housing prices and increase the purchasing power of buyers. It also allows means people with existing loans can refinance, save money and hopefully spend that money on goods and services and drive the recovery in aggregate demand. Unfortunately, although I think the "MBS Twist" is highly probable, I have very little faith in its power to stimulate the economy. As it has been tirelessly repeated through the economic blogosphere, we are stuck in a <i>balance-sheet recession,</i> and people are continuing to deleverage (see center left) even when, as my friend David Schawel has <a href="http://blogs.cfainstitute.org/insideinvesting/2012/07/30/should-you-pay-down-your-mortgage/">pointed out</a>, it might not be in their best interest.<br />
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEip7HzYVd1OWFRz2zt3DzQAQ6v-MKnm3gyJFWGbderwWGHxJc98zG_VwmHtwcAKTPMzKyAPBgZhdNyVaRzIzY-awCj7ON66jznOSiLMfw27JEHf95xd_e-C-tyA9LNJB3K_7NJw3qGqLhBl/s1600/secondary+spread.gif" imageanchor="1" style="clear: right; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="229" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEip7HzYVd1OWFRz2zt3DzQAQ6v-MKnm3gyJFWGbderwWGHxJc98zG_VwmHtwcAKTPMzKyAPBgZhdNyVaRzIzY-awCj7ON66jznOSiLMfw27JEHf95xd_e-C-tyA9LNJB3K_7NJw3qGqLhBl/s320/secondary+spread.gif" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">The "primary-secondary" spread, the difference between the<br />
yield borrowers pay, and what MBS yield.</td></tr>
</tbody></table>
While borrowers continue to deleverage, any impact from lower rates
will be limited and as mortgage debt outstanding continues to fall, the
marginal stimulative power of monetary policy, unfortunately,
diminishes.<br />
<br />
Additionally,there is evidence to doubt whether lower MBS spreads will be passed on to customers or whether the banks will <a href="http://www.economicmusings.com/post/28878650167/harp-tbtf-banks-laughing-all-the-way-home">keep the windfall</a>. Despite current coupons trading at record tight spreads, the "primary-secondary" spread remains, not only stubbornly high, but near all-time record highs! (see lower left). Proponents of the MBS Twist insist that the Fed can put pressure on the "primary-secondary" spread and push savings to borrowers by increasing (more in a second) their purchases of current coupons, but to me it is clear that the problem lies in the demand, not supply, side of loans. This is why, unless we see further expansion of <a href="http://en.wikipedia.org/wiki/Home_Affordable_Refinance_Program">H.A.R.P.</a> (Home Affordable Refinance Program) which increases the pool of homeowners eligible for refinance, I think the ultimate effect of an "MBS Twist" on aggregate demand will be limited and the ultimate economic beneficiaries will be banks and security holders who see their securities increase in price. <br />
<br />
That being said, I want to make it clear that I believe there is a very high probability of an "MBS Twist." I believe that with inflation declining, unemployment stubbornly high and total gridlock by the pathetic cowards and liars that make-up the legislative branch, Chairman Bernanke will continue to lead the effort to maintain the recovery on-track with the tools available to the Federal Reserve, limited as they may be. And judging by the first chart in this post, I am not the only one to think so. One of the reasons that I find the "MBS Twist" or a new round of MBS LSAPs as the most probable form of additional easing is that <i>the Fed is already doing the MBS twist.</i> Every month the Fed receives cash-flow representing interest and principal on their approx $530 billion in Fannie Mae 4.5-5.5% pools from the first round of LSAPs. The portion of that cash-flow representing principal repayments is reinvested into current coupon MBS in order to maintain the size of the Fed's balance sheet. In other words, every month, the portion of the Fed's MBS portfolio held in the new Fannie Mae 3s increases. The fact that this is something that is <i>already</i> happening makes me think that simply speeding up this process would be a natural extension of present policy. Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com9tag:blogger.com,1999:blog-2262329415199130690.post-29824642653142359762012-07-22T19:12:00.000-04:002012-07-22T19:12:44.390-04:00Emerging Markets and Grain PricesNominal grain prices are making new USD highs lately as the drought and heat wave reduce yield estimates. High food prices are believed by some to have been a contributor to the 2011 "Arab Spring" uprisings.
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgqoHZGjLY3a7G1D_b26DoyGWodo-raq9ZTyObLIsyv7oMjzyq-Bf82tOkB0M5Sq0jknJk5aRB73JvCfqvAN2qyJgutb9_zazYSlpAFLNZQWdWpHsspdAE4OcbEs-178agJC1yeOn5AcTiM/s1600/Arab+Spring+vs.+commodity+prices.jpg" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="157" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgqoHZGjLY3a7G1D_b26DoyGWodo-raq9ZTyObLIsyv7oMjzyq-Bf82tOkB0M5Sq0jknJk5aRB73JvCfqvAN2qyJgutb9_zazYSlpAFLNZQWdWpHsspdAE4OcbEs-178agJC1yeOn5AcTiM/s320/Arab+Spring+vs.+commodity+prices.jpg" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source:
"<a href="http://from%20qe2%20to%20arab%20spring%20-%20a%20lesson%20for%20the%20ecb%20/">From QE2 to Arab Spring - a Lesson for the ECB</a>."<br />
Sober Look, Nov 20, 2011</td></tr>
</tbody></table>
Although the prices we are seeing are not new highs in
inflation-adjusted USD, prior price peaks happened in the context of
strong EM currencies (weak USD) and robust or improving global growth.<br />
<br />
With global growth looking like it is <a href="http://soberlook.com/2012/06/visible-slowdown-in-global-economic.html">decelerating</a>
and EM currencies weak, current prices are signaling new peaks in terms
of EM currencies, leading to renewed risk of social unrest as well as
putting pressure on government subsidies and poor urban residents who
spend a larger portion of their wages on foodstuffs.<br />
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhe0wr23ImuOFsU_K_7GsAiHLFtEbOcXJ6FIg7zj_pNtqG5jpVKBFu1Fp0DNCOL5Kd2heZ6Ny1dmkMx2TgVjkm1byQHOW8NcbcTv359bph-6sKrVOh0EvFet_5Yj3ujndXxxhpsNLUQTtBz/s1600/Grain+Prices+&+EM+Currecies.PNG" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="190" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhe0wr23ImuOFsU_K_7GsAiHLFtEbOcXJ6FIg7zj_pNtqG5jpVKBFu1Fp0DNCOL5Kd2heZ6Ny1dmkMx2TgVjkm1byQHOW8NcbcTv359bph-6sKrVOh0EvFet_5Yj3ujndXxxhpsNLUQTtBz/s320/Grain+Prices+&+EM+Currecies.PNG" width="320" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Corn, Wheat, Rice, Soy Bean equal;-weighted composite<br />
adjusted for change in EM Currency Index value</td></tr>
</tbody></table>
While the effect of high food prices will be at least partially offset by resilient oil prices for oil exporting nations, who are ore likely to be food importers, small island nations and Sub-Saharan Africa are particularly at risk.<br />
<br />Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com16tag:blogger.com,1999:blog-2262329415199130690.post-69002244490706002932012-07-11T20:04:00.000-04:002012-07-11T20:04:02.000-04:00Corporate Profit Margins: Nothing to see here?One of the arguments against equities that has been tirelessly repeated by managers like Hussman and Grantham has been that profit margins were too high and were due for mean reversion. Profit margins are indeed high, at approximately +2.8 standard deviations, or 10.6%, as a result of low interest rates (low cost of capital), depressed labor costs stemming from high unemployment and a near record low effective corporate tax rate (~18.6%).<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhvwEhelcP7Ix7cnogJ0-iRvzrp1pswBv_tTs1ey6n6CAAceoGnoEhJ1iynRQ2OP78ZaUIrASGCKiu3GIgwtRdEeMEIdVQmUwURyCCtc4Q0W8yxGoY0z6u7EnJFs2uCk0cARZjgk2zHQl4Y/s1600/profit-margins-2.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="217" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhvwEhelcP7Ix7cnogJ0-iRvzrp1pswBv_tTs1ey6n6CAAceoGnoEhJ1iynRQ2OP78ZaUIrASGCKiu3GIgwtRdEeMEIdVQmUwURyCCtc4Q0W8yxGoY0z6u7EnJFs2uCk0cARZjgk2zHQl4Y/s400/profit-margins-2.PNG" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Standardized Corporate Profits After Tax divided by GDP</td></tr>
</tbody></table>
<div class="separator" style="clear: both; text-align: left;">
<br /></div>
<div class="separator" style="clear: both; text-align: left;">
The main argument for profit margin mean-reversion is that high
margins invite new competition while low margins discourage new
entrants. Profit margins are also important to investors because steep reductions in profit margins tend to be coincident with steep
drops in corporate profits.</div>
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiSIfWijGAWEPvX2cdHwFUKq8ZQje_dJwCehZMu-D4uKMZ6-i78t6fgAO8cO1ncxnmb6p2bj1kJMkWcMwgBITX-mxxjTSqIjRG3azQP9svj1eU2e9JoB2f2pIBBFcraRQD7S2LPQjOTU6C/s1600/profit-margins-3.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="217" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiSIfWijGAWEPvX2cdHwFUKq8ZQje_dJwCehZMu-D4uKMZ6-i78t6fgAO8cO1ncxnmb6p2bj1kJMkWcMwgBITX-mxxjTSqIjRG3azQP9svj1eU2e9JoB2f2pIBBFcraRQD7S2LPQjOTU6C/s400/profit-margins-3.PNG" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Standardized Corporate Profits After Tax divided by GDP and Corporate Taxes as a % of Prior Peak</td></tr>
</tbody></table>
While the prior charts may be alarming to equity investors seeing record-high (+2.8 stdev on latest quarter, or approx 10.6%) profit margins, we should ask ourselves, <i>what will cause this mean reversion?</i> The economy seems to be creating about <a href="http://research.stlouisfed.org/fredgraph.png?g=8FV">2 million jobs a year</a> right now, not exactly enough to put heavy pressure on labor markets. <a href="http://research.stlouisfed.org/fred2/graph/?g=8Ed">Fixed Investment</a> continues to be pathetic (more <a href="http://www.minyanville.com/trading-and-investing/fixed-income/articles/recession-depression-federal-reserve-fed-unemployment/7/11/2012/id/42324">here</a>). <a href="http://research.stlouisfed.org/fredgraph.png?g=8FW">The 10y yield</a> has dropped 50 basis points since the beginning of the year and 1.5% from last year's median. What is left? Are underlying gross margins really that high? If so, why aren't new entrants taking advantage of cheap labor, low rates, and plentiful capital to undercut the competition and get a piece of those juicy, juicy margins?<br />
<br />
Could it actually be the that maybe underlying margins on goods and services are not THAT high? Below you'll see a now similar chart which includes pre-tax corporate profits. As you can see, while pre-tax margins are elevated, they are much less alarming at +1.33 standard deviations and the rest is the effect of a <a href="http://research.stlouisfed.org/fredgraph.png?g=8FX">near record low tax rate</a> of 18.6%.<br />
<br />
(<i>Note:</i> above charts are quarterly and the one below is yearly since tax receipts are only available on a yearly basis.)<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRsJM6NlKnwOh7rcpl2MKOL4_y2NOizcR5m3CRnBDEvyAXSDoHyZd231C5l17QCBM79oJSUeeK6m2FS0PBcZKrE7b71cHeZocQEK9D5jLLHhFD-d8q75sVZ6qniGw8DI9FW-5lXZa4z-iM/s1600/profit-margins.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="240" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRsJM6NlKnwOh7rcpl2MKOL4_y2NOizcR5m3CRnBDEvyAXSDoHyZd231C5l17QCBM79oJSUeeK6m2FS0PBcZKrE7b71cHeZocQEK9D5jLLHhFD-d8q75sVZ6qniGw8DI9FW-5lXZa4z-iM/s400/profit-margins.PNG" width="400" /></a></td><td style="text-align: center;"></td><td style="text-align: center;"></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Standardized Corporate Profits as % of GDP Before and After Tax</td><td class="tr-caption" style="text-align: center;"><br /></td><td class="tr-caption" style="text-align: center;"><br /></td></tr>
</tbody></table>
In conclusion, it appears that the only danger to corporate profits in the short term is a large, sudden increase in the effective tax rate or a sudden drop in final demand leading to a drop in sales and profits.<br />
<br />
With interest rates still falling and a multi-year liability repricing cycle, there is little immediate danger from a bottom in rates. Additionally, a fixed investment and/or employment boom which drove the cost of labor upwards would mean increases in final demand and GDP, leading to shrinking margins coupled with growing top-lines, not exactly a disaster.<br />
<br />
Unless you see a recession in our very near future, it seems there's simply nothing to see here.Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com1tag:blogger.com,1999:blog-2262329415199130690.post-28893596007101393762012-07-08T18:27:00.002-04:002012-07-08T18:27:30.431-04:00CEF premium snapshot for week beginning July 9, 2012<blockquote class="tr_bq">
<i>One for the treble, two for the bass. Welcome to the great incredible paper chase, keep your boots laced if you want to keep pace</i></blockquote>
Premiums across the board increased. Covered calls remain the least ugly duckling, Bond funds getting kraykray. CEF investors holding funds trading at a premium to NAV would probably be well served by considering switching to ETFs or open-ended MFs.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgUoaXH4VXSJcFFkVx6T6tbMKK3sel8r5p9Vs5LadLUN_GwJsSIQDnd4ondDhBtb533-uBbyO-f0dIeYze0r14Fhz42PlsS-VxAdebcmdl49UeS3T0lVxSlHXjlntzXWUv01YmsmMT2Y_dK/s1600/Muni.PNG" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="179" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgUoaXH4VXSJcFFkVx6T6tbMKK3sel8r5p9Vs5LadLUN_GwJsSIQDnd4ondDhBtb533-uBbyO-f0dIeYze0r14Fhz42PlsS-VxAdebcmdl49UeS3T0lVxSlHXjlntzXWUv01YmsmMT2Y_dK/s200/Muni.PNG" width="200" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">National Municipal</td></tr>
</tbody></table>
<div style="text-align: left;">
</div>
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijut7hPEBNIw_GwwX_7s89iPyxlvbStIklMjNNhVl2x8hm32QrKOzeIvNbBDKpLLJRhWxA_2Tklm4NuJhfTNmjaGs6Mn9AlqpUvYyASsOVCNA_qbrdxm16LgGl26PGLidFDpwMNkdCKnYE/s1600/NY+Muni.PNG" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="179" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijut7hPEBNIw_GwwX_7s89iPyxlvbStIklMjNNhVl2x8hm32QrKOzeIvNbBDKpLLJRhWxA_2Tklm4NuJhfTNmjaGs6Mn9AlqpUvYyASsOVCNA_qbrdxm16LgGl26PGLidFDpwMNkdCKnYE/s200/NY+Muni.PNG" width="200" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">NY Municipal</td></tr>
</tbody></table>
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjEdvhl45sW1XFRmtBybK3OFmoi0kLHy8IxIXF6yuj-NrAIWoflPMPt8ZRnj4Vba0gxOvCS7Us3xbAkA3wHZ5ELcJyavmUxXRmiq0qEVCyBY4RMVCwFuYm3vpXP5v2q6qtTJmOo_OnHz1JM/s1600/CA+Muni.PNG" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="179" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjEdvhl45sW1XFRmtBybK3OFmoi0kLHy8IxIXF6yuj-NrAIWoflPMPt8ZRnj4Vba0gxOvCS7Us3xbAkA3wHZ5ELcJyavmUxXRmiq0qEVCyBY4RMVCwFuYm3vpXP5v2q6qtTJmOo_OnHz1JM/s200/CA+Muni.PNG" width="200" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">CA Municipal</td></tr>
</tbody></table>
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTz980yNUq1ciCyO4O6vH9rLeGFjDr11us1ojyA3ldEvX4qEdKLZYdZ64UOAfsIOsknlI_urdi_Xn4Gwq52hdKHFGL8VmSLcRGAURlh9hIXENykwvtmAxcCazZU2nngst90hrj6eupEIO_/s1600/HY.PNG" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="180" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTz980yNUq1ciCyO4O6vH9rLeGFjDr11us1ojyA3ldEvX4qEdKLZYdZ64UOAfsIOsknlI_urdi_Xn4Gwq52hdKHFGL8VmSLcRGAURlh9hIXENykwvtmAxcCazZU2nngst90hrj6eupEIO_/s200/HY.PNG" width="200" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">HY Corp</td></tr>
</tbody></table>
<br />
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmeQS8xgOYiwF7zjycOwOyvAQW7YXtO1o3-2ttbE6-B4UM4BdRy3AaZg7lGAUbX0-NJivUywWBkkgBBdaE_MQeWea5Eny_c_ETUaZ3KMbaBxVPrYxHLsmmNX0uTqa-5z-0nC2qEXigF5jp/s1600/Senior+Loan.PNG" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="179" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmeQS8xgOYiwF7zjycOwOyvAQW7YXtO1o3-2ttbE6-B4UM4BdRy3AaZg7lGAUbX0-NJivUywWBkkgBBdaE_MQeWea5Eny_c_ETUaZ3KMbaBxVPrYxHLsmmNX0uTqa-5z-0nC2qEXigF5jp/s200/Senior+Loan.PNG" width="200" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Senior Loan</td></tr>
</tbody></table>
<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="float: left; margin-right: 1em; text-align: left;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlaSs_zC2YCdzltuVukF5h-uPBQkjzkyRa6Fy49iuocBYApstqD4Wikle2mHCbl396AxNiWTyjUJ-SMeFcy16llJSjudT6T_n-mksiSr79RvOJVxR_cJrSVdlDo8teGNXrfXOUcZWxmJw9/s1600/Covered+Call.PNG" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="179" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlaSs_zC2YCdzltuVukF5h-uPBQkjzkyRa6Fy49iuocBYApstqD4Wikle2mHCbl396AxNiWTyjUJ-SMeFcy16llJSjudT6T_n-mksiSr79RvOJVxR_cJrSVdlDo8teGNXrfXOUcZWxmJw9/s200/Covered+Call.PNG" width="200" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Covered Call</td></tr>
</tbody></table>Anonymoushttp://www.blogger.com/profile/12854212312458729028noreply@blogger.com2