Weekly Commentary August 26th, 2013

The Markets

“So much depends / upon / a red wheel / barrow / glazed with rain / water / beside the white / chickens.”

Well, the U.S. Federal Reserve’s monetary policy is a lot more complex than the simple tools mentioned in the oft-memorized William Carlos Williams’ poem, The Red Wheelbarrow, but an awful lot is depending on it. In some of those countries that have been affected negatively by changing expectations about quantitative easing, the importance of chickens, wheelbarrows, and other basic tools to a family’s economic well-being has not been forgotten.

During the past 10 weeks, currencies in many emerging countries tumbled against the U.S. dollar on expectations the Fed will begin to taper off its bond buying program (which is known as quantitative easing). The Brazilian real sank like a weighted fishing line, dropping almost 16 percent. The Indian rupee dropped almost 12 percent. The Indonesian rupiah lost seven percent, and the Malaysian ringgit fell by a bit more than 6 percent during the period.

The Mexican peso and South African rand dropped, as well, but both have recovered some value, in part because they don’t have large deficits, according to The Indian Express. China and South Korea, which are strong exporters, saw their currencies dunk down, but both bobbed back up.

According to The New York Times, currency weakness caused several emerging markets to lose significant value recently. India’s stock market lost one-quarter of its value during the past three months in U.S. dollar terms, but market declines in local currency terms have been much smaller. A recent New York Times article pointed out, “…From the end of 2000 through the end of 2010, the developed market index rose a scant 5 percent. The emerging markets index more than tripled during the same period. Since then, however, the developed markets have risen nearly 20 percent, while the emerging ones have fallen about the same amount.”

As we’ve mentioned before, mean reversion theory suggests prices and returns adjust towards a mean or average over time. That raises an interesting question. Have recent market shifts been adjustments toward a mean?

the next big things… In May, The McKinsey Global Institute released its latest thinking on disruptive technologies. That is, technological advances which have the potential to disrupt the status quo and transform life, business, and the global economy as we know it. Among the dozen technologies mentioned in the report were:

• Mobile Internet is expected to improve productivity and delivery of service. McKinsey estimated one application – remote health monitoring – could reduce healthcare costs of by one-fifth. (Slide 1)
• Automation of knowledge work is a brain twister of a category that encompasses intelligent software systems, which could produce output equal to 110 to 140 million full-time workers. (Slide 2)
• The Cloud delivers services over the Internet or a network. It could improve productivity in IT infrastructure, application development, and packaged software by 15 to 20 percent. (Slide 3)
• Advanced robotics could improve the lives of 50 million people who are missing limbs or have impaired mobility. Also, industrial, manufacturing, and service robots may change the face of labor. (Slide 5)
• Autonomous or semi-autonomous vehicles could save 30,000 to 150,000 lives by eliminating potentially fatal traffic accidents. (Slide 6)
• 3-D printing may offer the ability to manufacture custom goods at home, while the medical industry may be able to bioprint tissue and organs in the lab. (Slide 9)

According to the report’s authors, these ideas “…can change the game for businesses, creating entirely new products and services, as well as shifting pools of value between producers or from producers to consumers.”

 

Weekly Focus – Think About It

 

“If you don't have time to do it right, when will you have time to do it over?”

--John Wooden, American basketball player and coach

Weekly Commentary August 12th, 2013

The Markets

Like the kid who sings loudly and enthusiastically at a grade school concert while wary peers dodge his O Sole Mio arm sweeps, the Federal Reserve has been getting a lot of attention lately. That didn’t change last week.

Markets pulled back from record highs after Chicago Fed President, Charles Evans, who has been a supporter of the Fed’s quantitative easing program, indicated the Fed could begin to reduce bond purchases at its policy meeting in mid-September. He reiterated the fact that moderating quantitative easing did not mean the Fed would begin to raise rates.

The Fed also garnered some attention for the contentious tone of discussions about who should replace current Fed Chairman, Ben Bernanke, when his term ends next January. Some of the rancor stems from contender Larry Summers stint as President of Harvard University which ended badly, in part, because of comments he made on “the issue of women's representation in tenured positions in science and engineering at top universities and research institutions,” and the fact his primary competition for the job is female.

Paddy Power, which bills itself as “Ireland’s biggest, most successful, security conscious and innovative bookmaker,” is taking bets on who will be appointed as the next Fed Chairman. On August 11, 2013, it gave the odds as: Larry Summers, former Treasury Secretary, 1-to-2; Janet Yellen, current Fed Vice-Chairman, 2-to-1; Roger Ferguson, President and CEO of TIAA-CREF and previous Fed Vice-Chairman, 12-to-1; and Don Kohn, current member of the Bank of England (BOE) Financial Policy Committee and previous Fed Vice-Chairman, 18-to-1.

Speaking of the BOE… the United Kingdom’s central bank did a fair imitation of the Federal Reserve last week when it offered forward guidance tying tighter monetary policy to unemployment levels. The U.K. bond market’s response to the BOE’s assurances that rates would remain low for some time was quite similar to the U.S. bond market’s response to similar declarations from the Fed: yields on Gilts – bonds issued by the British government – moved higher.

a new twist on a controversial issue… It hasn’t been that long since eminent domain was a topic of conversation in households across the United States. Just after the turn of the century, homeowners in New London, Connecticut tried to stop the city from invoking its powers of eminent domain to acquire their homes and use the land for new development that was intended to boost the local economy. In 2005, in a five to four decision, the Supreme Court determined that the distressed city could acquire the properties.

According to a 2009 Federal Reserve article, the response to the ruling was immediate and intense. The U.S. House of Representatives passed a resolution denouncing the court, as well as a bill requiring federal development funds be withheld from states and political subdivisions that used eminent domain in specific ways. In addition, a majority of states took action to limit the reach of eminent domain.

Today, eminent domain is making headlines again. In a strange twist, some cities are considering invoking eminent domain to acquire and reduce mortgage debt, keeping people in their homes as a means of boosting the local economy. According to economists at the New York Federal Reserve:

“With more than 11 million homes still “underwater,” the mortgage debt overhang caused by the housing bubble remains an impediment to economic growth and a burden on communities across the country. One possible solution to this problem is for state and municipal governments to use their eminent domain authority to purchase and restructure underwater mortgages.”

This time, banks and investors (including Freddie Mac, a government-backed company that is one of the biggest buyers of private home loan bonds) are protesting. They argue invoking eminent domain in this way could create losses for bond holders, as well as make lending institutions more reluctant to lend if the loans could be seized.

Will this thorny issue continue to ripen or will it die on the vine? It may depend on how fast home prices increase and how quickly the housing market recovers.

 

Weekly Focus – Think About It

“Rarely do we find men who willingly engage in hard, solid thinking. There is an almost universal quest for easy answers and half-baked solutions. Nothing pains some people more than having to think.”

--Martin Luther King, Jr., clergyman and leader of the Civil Rights Movement

Weekly Commentary August 5th, 2013

The Markets

You say to-may-to. I say to-mah-to.

You have to be a careful reader to keep up with the Federal Reserve these days. Last week, the Fed re-characterized the pace of economic growth in the United States from ‘moderate’ to ‘modest.’ According to Wall Street Journal blog, Real Time Economics, “economic data show that ‘modest’ is a touch weaker than ‘moderate.’” No matter how you parse the difference, it was enough to prevent the Fed from beginning to normalize monetary policy by cutting back on bond buying.

The Fed indicated that labor market concerns were a key reason for continuing quantitative easing (QE) at current levels. Investors at home and in emerging markets appeared to think that employment concerns and less robust economic growth in the United States were okay, as long as quantitative easing continued. Major U.S. stock markets finished the week higher, while stocks in commodity-driven emerging countries, and those with significant current account deficits, also moved higher, in general.

Americans looking for good-paying jobs may be less enthusiastic about the reasons for the Fed’s constrained outlook. According to The Daily Ticker, a recent analysis found that almost two-thirds of the jobs created during the first half of 2013 were in the lowest paying sectors of the economy, and provide income of about $15.80 an hour, on average. When you multiply that hourly rate by 2,080 (the number of hours in fifty-two 40-hour work weeks), it comes out to about $32,000 a year. That may help explain why the median household income in the United States has fallen from about $54,500 in June 2009 (the start of the current economic recovery) to about $52,098 in June 2013.

Here’s another interesting difference to ponder as you think about the near future — a future in which many expect China to be an important growth engine. Last week, that country’s manufacturing purchasing indexes were released.  The official Purchasing Managers' Index (PMI), which includes bigger firms, rose to 50.3 in July from 50.1 in June. Any reading above 50 indicates expansion. The unofficial index, compiled by Markit and HSBC index, which tracks smaller firms, fell to 47.7 from 48.2 for the same period. Any reading below 50 indicates contraction.

 

you’ve seen ‘em — television makeover shows like what not to wear and the biggest loser. By the end of the installment or the series, lives have been changed, presumably for the better. It remains to be seen whether Europe’s current makeover — a migratory one — will change lives for the better.

Unemployment is a key issue behind Europe’s makeover. According to Eurostat, unemployment in the EU-27 was at almost 11 percent in June 2013. That was slightly lower than May of 2013, but higher than June of last year. When you delve deeper into Europe’s unemployment, it’s clear that the problem is more pronounced in periphery countries, which typically are southern European. In March, unemployment in Germany (a core country) was about 5 percent, while in Greece and Spain (periphery countries) it was almost 27 percent.

Among younger populations, unemployment is even higher. In February 2013, 64 percent of young people in Greece were unemployed and 56 percent of those in Spain. This statistic is somewhat skewed because many younger people are in school.

Seeking greener pastures, citizens of many periphery countries have begun to emigrate. According to The Economist, a study by Real Instituto Elcano found that almost three-fourths of Spaniards under the age of 30 have considered moving abroad. Two percent of Portugal’s population has departed during the past two years, and a record 3,000 people are leaving Ireland each month. The destination of choice for many has been Germany.

According to The Economist, the exodus could exacerbate problems in high-debt countries:  

“Labor is one of the main inputs to growth, and a reduction in the size of the underlying labor force through migration will shrink potential output across the periphery, making existing debt loads harder to bear. This could be especially bad if young workers are the ones leaving. That would worsen the dependency ratio as well; there would be fewer potential taxpayers in Spain and Italy to pay for the benefits flowing to a rapidly growing population of pensioners. The greater these migratory flows, the worse the fiscal outlook for the periphery.”

As with any makeover, it’s difficult to know whether the end result will be positive or lasting, but one thing is likely. The European Union is going to look different in the future.

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Weekly Focus – Think About It

“When we are no longer able to change a situation — we are challenged to change ourselves.”

-- Viktor E. Frankl, Austrian neurologist and psychiatrist