Monday, December 31, 2012

The fiscal cliff of 1937

With all the current noise regarding the 'fiscal cliff' I thought a look back at when we had a real fiscal cliff would be interesting.

Steve Keen, an Australian economist I've mentioned before recently gave a presentation to members of Congress regarding the Fiscal Cliff of 1937.


In his presentation Mr. Keen describes the mechanism through which a dramatic tax increase coupled with an absolute cut in spending threw the US economy into a recession.  From 1937 to '38 tax receipts when up ~25% and spending was cut ~8%  While in the 1937 spending and taxes were a much smaller percentage of GDP, the large swings in their absolute numbers were enough to decrease the deficit from -2.5% to -0.1% or a change of 2.4% (source: White House)

Additionally the Federal Reserve shrank their balance sheet at the same time:

The wrong time to anti-QE
Source: Federal Reserve

The combination of Fiscal and Monetary tightening pushed the economy back into recession. (Vertical gray lines on above graph.)

Right now we are experiencing a similar situation: The US economy is working off the excesses of a burst credit bubble and federal spending and deficits are at an all time high.   

Spending and Taxes from 1930 on
Source: White House
As you can see above, spending is at at a peacetime high and taxes are near a post WWII low. (Both relative to GDP.) Combine the two and you have the largest peacetime deficit from 1900 onward. (The data from the White House doesn't go back any further than 1900, so there may be another time period before then however I doubt we have experienced peacetime 10+% budget deficits before.)

Today we can see the credit bubble bursting in a chronically high unemployment rate and sluggish GDP growth.  Unlike other downturns, our GDP did not rebound much. 

Source: Federal Reserve

A ~2.5% GDP growth rate after coming out of a recession is quite low as compared to historical norms.

Raising taxes too quickly combined with actual spending cuts on an already slowly growing economy could send us immediately into a recession.  This is what has Wall Street in a current tizzy and is already hitting consumer confidence.

Predictions about the future are tricky, especially when politicians are involved.

How much taxes go up, and if there are any actual spending cuts will determine how much of a fiscal drag hits the economy in 2013.  Right now it's all speculation and I'm not going to try to predict what Congress and the President will eventually agree to, before or after January 1, but there are a few items which appear certain:

  • Taxes will go up, but not as much as 1937 on a percentage basis
  • Spending will most likely not decline on an absolute basis
  • Federal spending is a much larger percentage of the economy than in 1937
  • The Federal Reserve will NOT shrink its balance sheet in 2013

How much taxes will go up and on whom is the unknown and that is what is creating uncertainty in the mind of corporations and individuals.  Until we have clarity both the markets and consumer actions may be volatile.

Additional reading:

I actually wrote about this 2+ years ago as I was studying the history of the Great Depression.

Thanks to
 @mbusigin 1937 fed data
 @AlephBlog When is a 'cut' really a 'cut' in Washington speak (hint, not very often)    

Thursday, November 15, 2012

Social media and... war

Last night I saw something rather peculiar come up on my twitter stream, retweeted by someone I follow:

Errr. What is this?  Turns out both the Israeli Defense Forces ( @IDFSpokesperson ) and Hamas ( @AlqassamBrigade ) are live tweeting the current conflict between them in Gaza!

Please note:  This post is not about which side is the aggrieved party or who is at fault regarding this situation, merely the fact that both parties are using Twitter, Twitter pics, blogs, and YouTube to present their side of the story in an attempt to sway public opinion to their side.  I'm not going to show either sides photos, videos or blog posts as the information can be quite graphic. Click on either parties twitter stream if you are interested in the gory details.

What I find morbidly fascinating is the idea of a military conflict being live tweeted.  It certainly is a Brave New World we live in.

Tuesday, November 13, 2012

Hugh Hendry watch, belatedly -- Buttonwood conference

Here's the latest from Hugh Hendry at the Buttonwood conference a few weeks back. Sorry for the delay in posting this and frequency of posts in general; I've been very busy in the personal and business realm.

Watch live streaming video from theeconomist at
ht: PragCap

Friday, October 12, 2012

Inflation expectations and QE(infinity)

I have posted before regarding inflation expectations in the US treasury market and I need to give you an update, especially so considering the recent round of QE as announced by the Federal Reserve.

A refreshed chart from the Fed of the inflation expectation spread (10 year nominal yield minus 10 year TIPS yield) teases out some interesting items to consider.

10 year nominal Treasuries minus 10 year TIPS (source: Federal Reserve

Note how we have recently broke above the 2.5%  Since the GFC it has rarely breached this mark and did not stay there for long.

Now look at when previous QE's were initiated. A graph by does the job.

While they are not to the same scale, you will notice the first round of QE was initiated during the deep dark days of the financial crisis.  The inflation expectation spread was near its low of the series and the world looked bleak.

QE2 was discussed mid 2010 and also coincided with an interim dip in the inflation spread at around 1.5%

QE(infinity) was just announced and our inflation expectation spread is already near the highs of the entire series.  

While the Fed and other market participants have their own flavor of inflation expectations they look at this series is near its highs. Before the GFC this spread didn't venture much higher and the Fed thinks they can get it higher now? The future is subject to change (of course) but unless we get some serious wage growth it appears to me the Fed is pushing up against a long term inflation expectation wall.  

As an example here's nominal Personal Consumption Expenditures.  It has been on a secular decline since the inflation days of the 80's and also notice how it recently peaked and appears to be rolling over again (ahem)

Nominal PCE - Source Federal Reserve

For some additional context here's the 10 year nominal and TIPS yield since 2004. Notice how now 10 year TIPS are now going for a negative real yield.

Disclosure: Considering selling/shortening duration on some TIPS positions

Friday, August 3, 2012

Media: Stop being stupid with your Olympic headlines and tweets

I thought this would die down rather quickly once the Olympic games got under way but unfortunately it appears I was wrong. Evidently most major media organizations don't seem to understand the Olympic games.  Folks, some of us want to watch the games and not know who will win the event beforehand!  I know this may appear to be strange but yes, it's true. I happen to be one of them.  I also like to go to movies and not know the ending beforehand.  I must be peculiar because the major media outlets appear determined to ruin the tension and build up to various Olympic events.


Are you so desperate to post that article or tweet that headline 2 seconds before some other organization does that you don't realize you are totally ruining the event for a significant portion of your viewership?

It's not hard, really... I'll give you an excellent example in contrast.

I censored some of the AP tweet so I don't ruin your Olympic experience.
Somehow this concept is beyond reporters with several years of college and degrees and stuff.

Two tweets about the same event, and the Small Town Tacoma News Tribune (and I mean that as a complement) @thenewstribune understands the concept of building tension in a story while massive Associated Press seems to be run by monkeys and spam bots (and I'm insulting monkeys in this comparison)

In case I'm not making my point yet, imagine if a reporter wrote a book review like this:
The new novel A Winter's House by rookie author June Anderson breaks new ground in the mystery/crime genre. In the end we find out the butler killed Mrs. Kavendish in the study with a candlestick, but not during the stormy evening as the author alludes to in her clever story telling.  No, she'd been dead for days...
The NBC Olympics web site titles some videos with the event and WINNER'S NAME. Um, we may want to actually watch the video before knowing who won, ok?

You are tweeting and publishing to a worldwide audience who may not be able to watch the events live.  I have my DVR at home filled to capacity with 3 channels of Olympic programming, please stop ruining it for me.

In short: STOP BEING STUPID WITH YOUR HEADLINES AND TWEETS!  I'm unfollowing every news source that does so. Trust me, if you are furiously tweeting spoilers about the Olympics, I can get whatever other 'news' you provide elsewhere.

p.s. I know I'm just one smaller blogger in a very large universe but I'm sure there are others who share my viewpoint.

Thursday, July 19, 2012

Negotiating with the Chinese

I recently stumbled across this video given at the Google campus regarding negotiating with the Chinese.  While much has changed since this presentation in 2006 (Google is no longer in China and the consensus of  inexorable healthy Chinese growth is now questioned) the perspectives on Chinese and American negotiating goals most likely have not.

 I was a party to business negotiations in Taiwan in 2001 and personally experienced some of  the negotiating tactics discussed in this video. Fortunately I had brushed up on some of this before the event and wasn't flustered by the time delaying or subtle put downs employed.

If any of my readers can confirm or deny any of the topics covered in this video I'd love to hear from you.


Tuesday, July 17, 2012

Hugh Hendry - 'Bad things are going to happen'

Hugh Hendry has spoken to the media again, this time in a little more subdued manner.  Well known for his video antics over the past few years he's toned down his rhetoric recently.  From the article it appears he hasn't change his investment outlook much but he does delve a little more into his trading style...

Excerpts from article:
In a debate on Newsnight in 2010 Mr Hendry told Joseph Stiglitz, the Nobel laureate economist, “Um, hello? Can I tell you about the real world?” And, after a pugnacious appearance on the BBC’s Question Time, he briefly became the most-talked about person on Twitter.
For the genteel, wealthy investors in his funds, it was all a bit too much. So Mr Hendry stopped all media appearances and concentrated on making money. His $460m flagship fund gained 12.1 per cent over 2011 and is up about 3 per cent so far this year. It has returned a compound annual growth rate of almost 10 per cent since inception in 2002, performing best during bear markets.
“What I found was that when I speak in person, and especially when it’s television and timing is so acute, it gives the impression that I am cavalier and, if you will, full of myself,” says Mr Hendry, speaking by phone from his office in Bayswater, central London.
Mr Hendry insists that his reputation as a “contrarian” investor is wrong, and that his approach is in fact to take advantage of the prevailing momentum in markets. “Our ideas are harshly disciplined by market trends. You will never see us pursue a homegrown idea when it is to the detriment of the prevailing trend.”

ht: @FGoria 

Friday, June 29, 2012

My natural gas & LNG presentation at 2012 Vail ValueX Conference

Embedded below is my presentation at Vail ValueX on some aspects of the North American natural gas market and how LNG (liquefied natural gas) exports may close the worldwide pricing differential.

Dislaimer: I do discuss some economic winners and losers in this presentation. I own a few of them but I'm not going to tell you which ones.  As an investor you should make your own decisions about what to own and I don't know your risk profile or need for current income, etc.

The topics of natural gas and LNG exports are very large and compressing it down to 15 minutes was a challenge.  I could only present the major factors I see driving price differentials.

The full list of presentations can be found at the Vail ValueX hosts' Scribd site:

ValueXVail 2012 - Greg Merrill

Monday, June 25, 2012

Jim Chanos' notes from 2012 Vail ValueX Conference

I had the pleasure of attending the 2012 Vail ValueX conference hosted by Vitaliy Katsenelson
While I will write more about my impressions here's a link to Jim Chanos'  notes.

VALUExVail 2012 - James Chanos

The rest of the presentations are available here -

Wednesday, May 23, 2012

Chinese slowdown hits iron ore prices

Getting accurate data regarding economic activity in the Middle Kingdom is always difficult. I've blogged about it before and have grown to look at circumstantial indicators for clues as to what's happening in there. Mr Chovanec and Soberlook are two blogs who've been writing about evidence of a slowdown for some time now.  

One of those indicators is sliding back down again and is close to the panic lows of last fall. Iron Ore prices did not bounce much from the October lows and are now inching downward again.

News of the Chinese refusing to purchase previously ordered cargoes of Iron Ore and Coal is additional data supporting the slowdown thesis.  A serious slowdown in China would not bode well for the world economy considering Europe's problems as well.  Keep an eye on Iron prices. If they fall through the October floor I'd be cautious.

Tuesday, May 8, 2012

Thou shalt not use market orders. Example #12,538

Repeat after me, thou shalt not use market orders.  

Today the equity markets are a bit queasy and US Treasury bonds are rising.  As I scanned my list of holdings to see how the markets are responding I notice something unusual.  VGIT, the Vanguard 5-10 year Treasury bond ETF shot up more than 40% right at the open and then fell back down to nearly the previous day's close.

Instant massive loss on a 'safe' investment, most likely from putting in a market order right before the opening bell.

VGIT is a less liquid ETF but this is ridiculous.  Less than 900 shares traded on this massive spike upward; it doesn't take a lot of volume to move a thinly traded stock or ETF and yes, even ETF's can go illiquid..

A very bad day for someone. 
Please don't use market orders when placing orders!    Look at the current bid/ask and the shares available at those prices.   Limit orders are a much safer way to go even if you really need to move a position in or out.  If you don't know the difference between a market and limit order please find out before you do any more transactions..

Disclosure: Long VGIT in some client accounts

Wikipedia entry on order types

edit: Upon re-reading I failed to accentuate when you don't use market orders.
Please don't use market orders when placing orders on thinly traded stocks or at the open
If you are buying 100 shares of Apple it's not going to make a difference. If selling something near the opening bell, wait a few seconds and see what the market looks like. 

edit 2: The price action on Facebook's opening day is another good example of incorrectly using market orders. The blog entry here: shows the brutal reality of those who all bought Facebook at the open immediately losing money.

This post deserves a rewrite as I flubbed up my point but regulators freak out when you 'change something' without proper documentation of the original.  I'll let my errors stand as a reminder to myself and I'm not going to expend the effort of keeping a copy of the original stored someplace for eternity.

Monday, May 7, 2012

A free file sharing virtual hard drive on the cloud -- Dropbox

While there are other competing services out there from Microsoft and Google I like this companies' offering for its simplicity and ability to share folders and files with specific friends or the public at large.

In short, you download a program and create a folder (originally called Dropbox, but you can change the name and location) on your hard drive. Anything you place in this folder is uploaded to the cloud and stored in a virtual location. Now comes the fun part. You download the software on another machine and kaboom, Dropbox automatically syncs the two folders. You place a file in the Dropbox folder on your home machine and it is automatically synced with your work machine.  You can control the bandwidth allocated to the Dropbox app if you are concerned about it hogging all your resources if needed.

It gets better:

  • You can share certain sub directories with specific people and there is also a Public directory so you can share files with the general public.  Their blog reports they are rolling out an auto archive capability of all your photos and video on your smart phone.
  • They keep revisions of all your files for 30 days. If someone screws up a file or mis crops a photo, no problem, roll back the file! 
  • It's free with 2GB of storage. They sell very large plans (up to Terabyte + sized!) if you are needing something more. 
You can download the free software here.
(I get an increase in my free storage space allocation if you use their software through that link, but that is the extent of my compensation from Dropbox)

I don't put my business data on Dropbox as I'm a bit concerned about security but for pictures, company research I'm doing at home, etc it is a great way to move files about. Several years ago I spent a lot of time and effort maintaining something similar at a small business and it was a pain in the ass that never quite worked right.

 It's a testament to the blinding pace of technological progress that a company now provides the same service in a much faster and easier format, for free.

Thursday, May 3, 2012

Natural Gas followup

A few days ago I blogged about natural gas and how we could have problems storing it all. The WSJ recently posted a video on this very topic:

Chesapeake Energy (CHK) would not be in the news as much if the price of natural gas wasn't so low.  Amazing how you only find out about the problems after the crisis occurs.... hmmmm

Considering the drubbing stocks have taken in this sector I am researching this area. These low nat gas prices will not last forever.

Wednesday, May 2, 2012

Hugh Hendry coming out of hibernation -- Video at recent conference

Mr. Hugh Hendry of Eclectica appears to have come out of his self imposed social hibernation. Below is a video from the Milken Institute conference where he is part of a panel discussing Europe's problems.  It is a long video but I suggest you watch it.

While Mr. Hendry appears to be still very bearish about Europe I do agree with the person on his right that now is the time to start looking for opportunities. (note, I said LOOK)  With all their problems and low stock prices there must be some incredible buys amongst all the wreckage that European austerity is creating. I'm not suggesting you buy now but start doing your homework.  Anyone have any ideas? I'm open to suggestions.

Thanks Alphaville blog

edit: Here's the details on the panel speakers

Monday, April 30, 2012

Eclectica Fund commentary by Hugh Hendry

Hugh Hendry (Hedge fund manager of Eclectica fund) recently released his April commentary which you will find below. (Thanks ValueWalk)

Mr. Hendry has been less visible recently so it is nice to hear his most recent thoughts.  As always he provides some thought provoking ideas and historical analogs to our current situation.  It will be very interesting to see if his ideas and predictions are correct.  Like the name of his fund, his view are 'eclectic'.

April 2012 Hugh Henry

Thursday, April 26, 2012

Will we run out of storage for Natural Gas?

The price of natural gas has been falling throughout 2012 and is making multi year lows.  You have to go a long way back to find sub $2 natural gas and considering the price of oil is near nominal highs this is unusual.  (Yes I know there's not of much a substitution effect between NatGas and Oil but work with me here.) 

Natural Gas spot price
So what's driving this drop in gas prices? Some of it can be attributed to a warmer winter but the development of shale gas and fracking technology has opened up whole new geographic areas which were previously thought to be uneconomic to drill for natural gas and oil. (EIA article on the topic) This has increased production (sorry, but peak natural gas has not occurred yet)

This additional production has increased inventories and driven down prices. How much is impressive when you look at long term natural gas inventory figures.

It appears inventory bottomed around March 9, 2012 at 2369 Bcf (Billion cubic feet) where the recent seasonal minimum is around 1600 Bcf. Over the entire data series natural gas has never bottomed with so much already in storage.  This has hit prices. Hard.

One would presume that with spot prices so low, production would be curtailed and bring the supply and demand back into balance. This may not happen fast enough.  Even with very low spot prices production is still higher than last year. Couple this with already higher than average inventory numbers inventory and you have falling spot prices.

Nat gas production still high
source: EIA
Could we run out of storage for natural gas before the winter drawdown?  It's going to be a race between declining production (if any) compared to already bloated inventory figures.  I quantify the challenge below.  Each yearly line shows the injection rate needed to fill inventories to capacity each year. Consider it a "glide path" of how much you'd need to produce each day until the peak inventory day (around the middle of November) The injection rates are not linear throughout the year but comparing the curves is instructive. As one can see in 2012 the hurdle is very low.

Right now the injection rate for 2012 can be ~33% lower than previous years to completely fill up inventory by the middle of November.  

IF you see the 2012 line continue to drop as time progresses and remain well underneath the 2009 line storage may very will fill up.  We have another 200 or so days to go; I'll be updating you over the summer.

Disclosure: short UNG

Thursday, April 12, 2012

Pipelines and oil - Canadian crude will get out

I previously posted an article about the intersection of oil and politics and wanted to update you on one of my statements
Obama may feel the need to stop this project for political purposes but all he will succeed in doing is building more pipelines in Canada going east and west and sending that oil to Asia.  
Kinder Morgan, a large pipeline / energy company in North America is seeking firm commitments from oil shippers to expand their Trans Mountain Pipeline to the Canadian West Coast.  From Alberta Oil Magazine
Kinder Morgan Canada said yesterday it would extend an open season as it seeks firm commitments from shippers for an expansion to its Trans Mountain pipeline to Canada’s West Coast. The Canadian arm of Dallas-based Kinder Morgan aims to double capacity on the Pacific-bound line, from 300,000 to 600,000 barrels per day. Among other products, the $3.8-billion expansion would carry additional volumes of oil sands to a port at Burnaby, British Columbia, for export to Asia-Pacific markets and the West Coast of the United States.
The expanded oil production in Canada and the Midwest is creating a localized glut of oil and various companies are capitalizing on this price differential.

Western Canada Price Differential
Source: Bloomberg
While there are quality differences between these two benchmarks one can see how the spread has widened recently.

Regardless of the decision on the Keystone pipeline, Canadian oil will (eventually) get out to the worldwide marketplace.

Additional reading:

Friday, April 6, 2012

Before you panic about the employment report -- Some context

The monthly employment report was released today and while the economy continues to add jobs the report did not meet expectations.  (As of writing this on Friday afternoon SP500 futures were down 1+% while long term bond futures were up +1.3%)

Here's a longer term chart of the year over year percentage change of total employment as reported by the government and ADP. (ADP is in red)
Source: Federal Reserve

Employment is still growing but the rate of growth is looking like it may top in the near future.  If in the next couple of months you see these metrics really roll over then I'll be hitting the REAL panic button but right now the slow grind upwards still appears valid.

That being said I'm not suggesting you go out and buy stocks.  If America slows down from our already tepid growth as Europe falls back into recession and China continues to slow the world could be in some serious trouble. (All in all I'm not too enthused about equities right now as they have already had a huge run from late last year.)

Just please keep this chart in mind if the markets are down on Monday and the financial press is in a lather about it all.

Tuesday, March 27, 2012

Peering into China via trade statistics

Getting accurate information on China is a challenge. While its hard to prove they are making their numbers up I don't put much credence in many official statistics released from the Glorious Workers Paradise. (WSJ June 2011, Reuters December 2010)

Fortunately there are other ways of observing China, from their borders specifically.  Trade statistics between the Middle Kingdom and the US is actually reported and available from US sources.  The story they tell show of slowing trade between the countries in both directions.

Year over year % change of 3 month average
Source: Federal Reserve
While the graph above is smoothed and lagged quite a bit one can see both China and the US's decline in 2008/09 and China's massive resurgence in 2009 and the US a few months later.

Right now the story is also one of declining growth of trade in both directions.  

Of course trade partners may and will shift their vendors around from country to country so this data should be looked at with some large error bars on the data, but this slowdown is something to keep an eye on as a coincident/lagging indicator of each countries economic trajectory.

Wednesday, March 14, 2012

Diesel usage diverging from overall economy

While the economy has been recovering nicely from the Great Recession there are some interesting divergences which are popping up with this recovery.  One of them which has been discussed elsewhere in the blogosphere (sorry no links) is the apparent divergence between fuel usage and economic activity.

Diesel fuel usage
The Ceridian Index reports monthly on diesel fuel used by the trucking industry.   Unlike retail sales which continues upwards the Ceridian fuel index is now declining on a year over year basis. From their most recent report you can see the decline.

One can see in the next chart the apparent divergence between retail sales and diesel usage.

The researchers at Ceridian note the divergence as well and have a possible solution  Unlike the rest of the economy which is improving on a year over year basis, the housing market remains stuck in the duldroms and is still sputtering along the bottom. (See page 6 in the above linked report)

While productivity improvements are also possible I find it unlikely the rate of improvement would be enough to create the entire divergence.  Perhaps the lack of a growing home market and improved fuel usage (or the continued virtualization of our economy) are enough to close the gap between retail sales growth and flat fuel usage.  Only time and further research will tell.  Regardless this indicator bears watching.

Fuel usage and retail sales

Monday, March 12, 2012

Revising employment data

In my last post I promised to look at how employment data is being revised over time. On Friday the latest employment data was released and previous data was revised upwards in both the seasonal and non-seasonal data series. While this graph below shows data from just last months revision I may start showing multiple threads to see how the revisions change over time once we have more data.

I know, not much data to look at yet. Hopefully we'll see something interesting as time progresses. 

Wednesday, February 8, 2012

This post (and employment data) will be revised

The recent employment report has been a great point of contention between the bulls, bears, and the black helicopter crowd. I won't rehash the report but there's something I mentioned in a previous posting about employment seasonality that caught my attention.

The beginning of a new year brings a large number of layoffs as seasonal workers for the holiday shopping rush are released.  As you can see from this first graph the non seasonally adjusted data and adjusted data vary greatly right now.
Total nonfarm payroll 
The difference is rather obvious to see but lets transform the data a bit and look at the difference between the normalized and raw data.

Subtracting one from the other exposes just how much the raw data can vary from the the adjusted data in an attempt to smooth out the seasonality of the data.  As can be seen we are at the peak of this delta and it will most likely be revised in the future due to the fact we are that noisiest point in the data collection period.  Will it be revised up or down? I haven't a clue, but I'm going to watch it and report to you how much these data series change over time.  Stay tuned.

Monday, February 6, 2012

A housing update -- at best a flat market

Over the last few years during conversations with clients I've frequently been asked my opinion about the housing market and whether now is a good time to buy.  Home prices are naturally a point of conversation as they are a large part of most people's net worth and the loss of equity is preventing some people from moving up or refinancing.  So the question of whether we are at the bottom of home prices is an important one.  Unfortunately I don't think we are at the absolute bottom of home prices and we will most likely continue to see a slow decline in prices in the near future.  My non-prediction for 2012 is we will not see a rebound in home prices; at best we'll see a flat to slightly down market.

Home prices have strong local factors so this conversation is about national trends, your local market will vary.

Unfortunately right now home prices are continuing their decline nationwide:
Home prices still dropping - (Source: Paper Money)

Outstanding mortgages still contracting
Mortgage loan balance still declining
There are several headwinds the housing market needs to overcome before it is fully healed. This chart shows the change in mortgage values outstanding since 1975 (Source: Federal ReserveLooking at loan balances to predict home prices may seem counter intuitive but remember a rising total national loan balance means there are more buyers (and borrowers) entering the market.  Some interesting aspects of this chart are how even during other previous recessions (shown in gray) the value of outstanding mortgages continued to rise on a year over year basis; until our most recent recession in 2008/2009.  This was the first time during this entire data series when the total value of all mortgages outstanding declined on a year over year basis. One would not be engaging in hyperbole to call our current decline in home prices exceptional.

An overhang of foreclosed homes
While it appears the primary wave of home foreclosures is past us there still is a large backlog of homes in the foreclosure process. Until this backlog is completely cleared and returns to more 'normal' levels, the amount of housing coming on the market by 3rd parties (not the person who currently lives/owns the home) will put downward pressure on prices.

Single family delinquency rate (Source: CalculatedRisk)

Another negative factor is the hidden inventory of homes out there from people who want to move up or out but are waiting until home prices stabilize before putting the place on the market. I personally know of a few people who are accidental landlords and are hoping and waiting until prices stabilize before putting their rentals on the market.  While this is purely anecdotal I'm sure its not just a local or isolated phenomenon.

Renting versus Owning coming into balance
Fortunately there are some positive factors which should mitigate a continued decline in home prices.  Home prices and mortgage rates have declined to the point where a mortgage now equal to rent.
Rent versus Owning (Source: Soberlook)
As you can see for a very long time it was cheaper to rent versus own. We are approaching a point where this may invert and owning a home would be cheaper than renting. There are other upkeep and time costs associated with home ownership (as a homeowner I can assure you there are many!) but the primary costs are approaching parity.  

Clearing the excess inventory
The number of unsold homes is beginning to stabilize as a percentage of US population.  The hidden inventory is of course hard to measure but at least we are getting closer to 'normal' for this data series
Unsold homes as % of population - (Source: Sober Look)

The long decline in construction spending does appear to be finally over which will help the building trade and stop being a drag on overall GDP growth.
Construction finally bottoming? (Source: Federal Reserve)

Even though the housing market decline appears to be slowing forecasting when we finally reach bottom is not something I'm willing to predict right now. I believe the worst of the declines are behind us so if you are looking for a home now would be a good time to start looking but be picky and drive a hard bargain! There is going to be lots of supply coming on the market over the next few years.

One aspect of the crushing decline in home prices is it has popped the speculative mindset so very prevalent in American thinking a few years ago. (I'll admit to falling a little under that spell myself)  Take your time and find a house to live in, not one for profit.

Additional reading:
Calculated Risk calls a housing bottom

Monday, January 23, 2012

Observation of the day: Greeks are not Germans

It may appear an obvious observation but to the euro and (for a while at least) the bonds markets Greeks and Germans were the almost exactly the same. Twins.

Two recent pieces on public radio highlight how very different from the Germans the Greeks can really be.

The first radio spot describes the failed efforts of a Greek computer scientist to make the revenue system (the tax man) more efficient in Greece. All he thought they needed was a little technological help to point them in the right direction.  Heh, not quite.

This longer piece (nearly an hour) aired this weekend and I caught it on Saturday.  It goes into the desire to create the euro and how Greece basically lied to get into the eurozone and the epic borrowing binge Greeks went on after 'easy money' appeared after the Euro was introduced.  While its long it is a good overview of how Europe got into this mess.

Greece's credit history is not the best.  Since their independence in the early 1800's they have spent more than 50% of their time in default. (This time is different, 2008, Reinhart & Rogoff, page 99) Do you really think they would adopt the fiscal discipline of Germany after being handed their unlimited gold card?

ht @BarbarianCap

Thursday, January 19, 2012

Baltic Dry Index falls off a cliff

The Baltic Dry Index (spot shipping rate for bulk commodities like iron ore, grain, coal, etc) recently fell off a cliff and has not seen these levels since the dark days of early 2009.
While one can say there are legitimate supply problems (a huge overhang of new ships coming online from the order surge pre financial crisis of 2009); to see such a dramatic drop is impressive and deserving of attention. I have been quite bearish on China for quite a while on this blog (although now that their market has been thrashed and policy changes appear to be taking place I may have to alter that opinion) and the sudden fall in the index may be due to a lack of  import volume into China. We'll see in a little bit if this drop in the Baltic Dry foretells a real slowdown in China...

Source: Stockcharts

Wednesday, January 18, 2012

Obama shuts down Keystone pipeline. The oil must flow!

It appears the Obama administration will block approval of the Keystone pipeline.

Your political leanings aside, this will not stop 'dirty oil sands' oil from getting out. I was going to work up a nice post about how Canada can ship the oil east or west but NPR beat me to it:

Philip Verleger, an economist who specializes in oil markets, says even if environmentalists convince Obama to block the Keystone XL pipeline, it won't stop the growth of production in the Canadian oil sands.
"With prices around a hundred dollars a barrel globally, that oil is going to make it to the market somehow," Verleger says. "The development may be slowed for a year or two. But one can move the oil west on the existing Kinder Morgan pipeline. They could expand pipelines east. Those pipelines already exist, and they can be expanded."
In fact, Enbridge, a Canadian energy company, recently asked Canadian regulators for permission to reverse the direction of one of its pipelines in Ontario, which many see as the first step to move more Canadian oil to the American East Coast — and relieve some of the Canadian oil glut in the upper Midwest.
Not only is the oil going to flow east but the article mentions Kinder Morgan planning to increase the flow westward to British Columbia and then down to the Pacific Northwest and out to Asia as well.

The NPR article continues...
But demand is the key, say most economists. If you can get American drivers to buy less gas — by raising fuel efficiency standards, as the Obama administration recently did — then, they say, you stand a much better chance of slowing production in the oil sands.
Sorry but these are economists? American drivers are just one user of energy, don't forget all of Asia, India, South America, etc.  

All is not lost
For those of you worried the end is nigh and we will run out of oil soon and that will be the end of us all I would like to point you to this graph and article from the Economist

Energy used per unit of GDP has been declining in America since the 1920's. For nearly a century America has become more efficient at extracting more value out of each barrel/btu/pound of energy and the trend is to greater and greater efficiency.

Furthermore oil is not the only form of energy we have available in America.  Through new techniques the amount of natural gas in America is at all time highs and current prices are extremely low and production continues to rise. From Sober Look

But I digress from the Keystone pipeline.  Obama may feel the need to stop this project for political purposes but all he will succeed in doing is building more pipelines in Canada going east and west and sending that oil to Asia.   Would it not be better to have the cheaper oil captive in America and depressing our prices relative to the rest of the world? Believe it or not but oil has been cheaper in America than the rest of the world for nearly a year, and some of that is due to the increased production up north in Canada. 

 For those of you concerned about the risk of the Keystone pipeline, there are already skads of them all over America

The Keystone pipeline would not have reduced our energy 'dependence' from external sources but would you rather buy our oil from next door Canada or Saudi Arabia and Venezuela?

Additional Reading

Tuesday, January 17, 2012

Hugh Hendry as the Plasticine Trader

Late last year I highlighted a 5 part video series on Hugh Hendry in one of his steadily declining public appearances. In it he used a key term to describe his trading aspirations; the 'Plasticine Trader'

Here's a few excerpts from that series, completely lifted from a new blog called Chasing the vig. I guess I have a new book to put on my reading queue and a new blog to follow.

I have clipped the blog post down quite a bit so I suggest you click on over and read the entire entry. I have also highlighted and bolded some sections I found interesting

Steve Drobny's book The Invisible Hands includes one of the best interviews of a fund manager/trader. Ever. The chapter is called The Plasticine Macro Trader and it is none other than Hugh Hendry, manager of the hedge fund Eclectica Asset Management. This is how we should be thinking and trading. Also, he's highly entertaining. Read the entire thing, but here's some snippets:
Today’s long-only stars operated during a period of time where investors did not require a macro compass.  Today your average long-only guy does not spend much time looking at interest rates, currencies, debt levels, and other key macro variables. I have even been to conferences where fund managers have boasted, “I don’t know where oil prices are going; I don’t know where interest rates are going; I don’t know anything about the government.”  . . . For the last 30 years they could get away with that nonsense, but now at a historic turning point they are being found out.

Again, remember, I believe there is a degree of predictability to what has been happening in markets for the last 10 years. I believe that our generation is embarking upon a long period of unwinding financial excesses. Stock market returns could be terrible for the foreseeable future. If you believe people like Niall Ferguson, debt deflation eliminates all of the gains from the preceding boom, it purges everything. By 1974, we had eliminated all of the real gains from the American stock market since 1906. If we consider Japan as an example, the Topix would have to trade at 300 (or one third its present level) to be comparable with the lows reached during the 1970s on Wall Street. At this point, all of the real gains since the index was reconfigured in 1969 would have been eliminated. . . . 

Have the courage to be different, the courage to risk the ire of others for the sake of being right; to fight rather than embrace compromises everywhere. We have to encourage rebellious notions such as playfulness and curiosity. There is no one correct way of doing things that is set in stone. Periodically managers should be open to trying different approaches.

George Soros explains a version of this phenomenon when he says, “Invest first, and investigate later.” But this is heresy in the institutional money world. When I suggest stuff like that, the number crunchers and the box tickers write down, “crazy guy” and make their polite goodbyes. But every so often a heretic turns out to be a genius.
. . .
Even a true contrarian is only really contrarian about 20 percent of the time; it’s all about choosing the right moment to fight convention. The rest of the time is spent trend following. So I guess I am a trend-following contrarian. I come back to describing myself as a disciplined deviant. But every description that I have for myself is an oxymoron, and when I present my views, most people just think I’m a moron.

I have Tourette’s syndrome—I say “fuck” at all at the wrong times. One of my mentors taught me how to articulate that Tourette’s and then play the odds, become trend following and recognize when the elasticity becomes so extreme that your Tourette’s becomes valid and has the possibility of profits.

I jokingly claim that my best investment decisions come from being a paranoid schizophrenic. I hear voices in my head. Subconsciously and explicitly I seek to create a macro prejudice. And so there’s an ongoing debate by those voices in my head. But the scary thing is that I make investment decisions based on these voices. And so does everyone else. I just talk about it openly and honestly. When I make such decisions I become very fearful, paranoid like a schizophrenic, that these decisions may jeopardize my investors and my portfolio. I would contend that this fear makes me a better investor.
. . . 
That’s the hook; it is one thing to create the intellectual color but it doesn’t go into the portfolio until it starts to gain the attraction of relative momentum. I need the legitimacy of other curious strangers before I get involved.

Last summer I was on CNBC talking up Potash [Corporation of Saskatchewan], saying it was the best positioned company in the world when I suddenly realized everyone was agreeing with me. So I got out. Thank God I can reject my own advice because from July to October of 2008 its performance was diabolical.

The thing that I’m most fearful of is a focused fund, or a portfolio of 20 best ideas, which is a concept that marketed well a few years ago. The reason this idea can prove disastrous is that “best” is an emotionally charged word. Giving up on your best idea is the same as admitting that you’re wrong, something crucially important but very difficult to do.

I don’t believe that there is any real diversification left in the world today, at least not the kind of diversification to which you refer. And the shocking nature of the results in 2008 demonstrates this fact. We live in a world of binary events. Over the last 10 years, markets have oscillated between inflation and deflation, and people are either all in or all out. What we’re trying to do is make sure that we’re leaning at the right time, correctly anticipating the oscillation.
. . .
The same “upside down” logic prevailed in 1979 when Volcker became chairman of the Fed. You had this new sheriff in town who was honest and tough. He was going to raise interest rates to make the economy very weak in order to parch the system of its inflation. He was a dream come true for a bond bull, and yet bonds got destroyed whilst gold doubled to $800 in three months. (See Figure 13.8.) The problem was that Volcker had to come clean on the Fed’s dirty little secret. In order to have the legitimacy to be so hawkish, he had to admit that the problem was inflation; investors panicked and scrambled to protect themselves with gold. A hawk produced a melt-up in gold. Could the dovish Bernanke produce a similar melt-up at the long end of the bond market?
. . .
We are spending all of our time looking for inflation because the Fed will be slow in raising interest rates while the roof is caving in. The private sector’s desire to unburden itself of debt is so great that debt deflation seems much more likely. And if it rolls over with everyone loaded up on risk again, playing commodities and inflation expectations, bonds could go parabolic. The bull market in government bonds is one of the greatest bull markets of all time, and bull markets of that magnitude do not end with a whimper.

Typically my work is all about creating context to establish an environment where I might want to take risk. The challenge with risk management is finding the appropriate moment to expose yourself to that risk. I don’t think the right moment has come to pass for Japan just yet, but this is an idea that I have fermented for five years. Back then, I said that for the trade to work, we would need an extraneous economic shock which pushes dollar/yen down to around the 80s, and we have essentially been there. I am always in danger of wanting too much, but I am looking for those levels again in any subsequent round of global risk aversion. If that happens, I fear the Japanese will debauch their currency in an attempt to generate inflation to monetize their considerable public sector debts. With the majority of the private sector still invested in post office savings, such a step would cause a panic to buy equities and the Nikkei could go back to 40,000. Typically it requires 25 years to break a previous nominal price high in an asset class that has suffered a bubble. So who knows, maybe this is the trade for next decade? They have covered the place with kerosene, now all they have to do is light the match.

I live an interesting life. I made 50 percent in October 2008 and my biggest investor fired me. He said he had a manager that was down 30 percent on the year, but that manager “gets it,” so he was going to stay invested with him. Meanwhile, I made 30 percent on the year and I get fired because I don’t get it? This is the curse of my life. I seem to collect all sorts of witty dinner party anecdotes from my experiences, but I pray for a less interesting life.

Markets are irrational but they are right at every moment. They are right until they are wrong. You have to marry the notion of being right or wrong with being right with the timing of a given proposition. This is not a business that indulges intellectual prejudice.

Thursday, January 12, 2012

Seasonality and initial unemployment claims

Weekly initial unemployment claims were released today and they showed an increase to 399,000, countering the recent downward trend.  Details can be found at the DOL

I would not make much of the current gyrations, up and down. As the graph below shows, right now we are at the highest seasonal peak of layoffs/firings.  Each year you can see a massive increase in initial claims just around the new year. This makes estimating the trend very difficult.  (Translation, put very large error bars on data around the new year)

I wonder how many financial models out there reduce the weight of this data (and other series) when they are less accurate?  

Here's the two data series on a year over year basis.  While initial claims are still declining the rate of decline appears to have leveled off.