Commodities: Inflation or Speculation?

Kindly submitted for your consideration and approval:


Note: Your consideration would be greatly appreciated; the approval part, however, should not be interpreted merely as a request.

S&P Historical Earnings Analysis

Adapted from Robert Shiller's data set. Note that the darker blue line attempts to compensate for the dramatic swings in quarterly earnings to produce a "normalized" P/E ratio. This analytical transform may be particularly illuminating during times where earnings growth may be heavily driven by borrowed money -- borrowed money that, in turn, was cleverly offset as a liability on balance sheets by the asset appreciation created when everybody borrows money they can't pay back to drive up asset prices to use as collateral to borrow even more money they can't pay back:

Credit-Driven Bubble Economy?

Old graph I made a while back that I didn't get around to posting for lack of temporal resources:


Note: This is a housecleaning operation, not a blog revival.

Runaway Inflation Nightmare - May 2007

Let's take a look a the stagflationary nightmare that is the U.S. economy by examining the May CPI which just came out. Below we have a year-over-year graph of both the Core CPI and the Cleveland Fed's Median CPI:


Er...

Damn. That's really going to whip the deflation nutters into a frenzy.

Clearly something is wrong with these measures. And who cares about the inflation in Cleveland anyhow?

Let's see if we can filter the data to get a truer picture of what's going on...


That's better.

Now let's take a look at the headline CPI data (the one that includes food and energy, which some Washington bureaucrat apparently thinks we don't need) plotted in a year-over-year fashion. This one is unfiltered:


As you can see, overall inflation has been making quite a comeback recently. Since this data is more accurate than the previous set, I'm not going to take the time to filter it; I'd simply advise the reader to ignore the slowdown in the past couple of months.

That's all for now. I'll try to update this post later with a bunch of links to sites where you can buy gold online.

Should You Worry About the Negative Savings Rate?

On CNBC today a dialog took place between host and guest explaining why the negative personal savings rate in the U.S. wasn't really a concern. Specifically, they argued, it doesn't include contributions to 401k plans and other retirement accounts.

This claim comes up quite a bit in discussions as to why wary investors shouldn't fret about the U.S. economy before taking the plunge into the latest Wall Street offering. Certainly, on the surface, the argument has merit -- if workers in the U.S. are placing up to 15% of their income in a "personal savings void" that isn't included in the official government statistics, then there's far less cause for economic trepidation amongst the ranks of squirrely Wall Street holdouts.

But is this claim true?

Let's see what we can learn from the mighty BEA (Bureau of Economic Analysis) archives...

First, we'll look at the personal savings rate calculation described here:

personal saving rate — saving as a percentage of disposable personal income

Next, we'll consider the following definitions that appear in the BEA glossary (just the good parts appear below):

Disposable personal income. Total after-tax income received by persons; it is the income available to persons for spending or saving.

Personal saving. Personal income less the sum of personal outlays and personal current taxes.

Personal income. Income received by persons from all sources. It includes... compensation of employees (received)...

Compensation of employees (received). Wage and salary disbursements and supplements to wages...

Wage and salary accruals and disbursements. The monetary remuneration of employees, including... voluntary employee contributions to certain deferred compensation plans, such as 401(k) plans...

Both the income and saving figures used in the savings rate calculation include retirement account contributions. So by implication, the personal savings rate does too (if you dig a bit deeper you find that neither personal outlays nor personal current taxes contain retirement contributions, so these can just be dropped from the personal saving equation).

The key point to note is that these retirement account "deductions" are not some special pre-tax income excluded by the "after-tax" qualification of disposable income. These just come from normal income that has a portion of the taxes deferred. In other words, the personal savings rate does include contributions to 401k plans, IRAs, etc.

Correct me if I'm wrong.

(I'm dropping the pretense of collaboration with the reader here -- you're on your own from now on.)

Also, note that I'm following a chain of logic to reach this conclusion and am crediting the BEA with using a similar approach in their methodology.

Correct me if they're wrong.

Q.E.D.

Afterward: In defense of the naysayers, some more digging around reveals that there are potential flaws in the current personal savings rate calculation -- apparently, capital gains are not counted in the personal savings rate (likewise, losses aren't deducted). This may be a significant omission, but ultimately it has little to do with the issue of retirement contributions (which prompted the original discussion).

So...

Should you worry about the negative savings rate?

I was hoping CNBC would replay their earlier broadcast so I could take notes and formulate some additional insights, but a poker game came on instead.

I'll let you know if anything new comes up.

"They're not Making Any More Stocks!"

USA TODAY reports that private equity is shrinking the pool of available stocks on the market:

Wave of buyouts shrinks public pool of stocks

Investors might not realize it, but private equity's public-company pig fest is leaving them with fewer choices when it comes to U.S. stocks...

Meanwhile, 107 U.S.-based companies have issued stock in initial public offerings. That leaves the market with a net loss of 110 stocks, Capital IQ says.

The shrinkage is noticeable. There aren't 5,000 stocks anymore in the Dow Jones Wilshire 5000...

And it's not just small companies going away. This year, 12 members of the S&P 500, a benchmark index of large-company stocks, have been taken out by private buyouts and acquisitions, says Howard Silverblatt of S&P. An additional 17, including Bausch & Lomb, will disappear once their buyouts are completed, he says.

"Buy now or get priced out forever!"


Sound familiar?

It should. This is they same sort of thinking that lead to a glut of overpriced housing in the U.S., with predictable results:

U.S. Median Home Price Tumbles to 2-Year Low in Slump

U.S. home prices tumbled to a two-year low in the first quarter, with declines in almost half of U.S. cities, the National Association of Realtors said.

The median price for houses and condominiums slid 1.8 percent to $212,300 in the first three months of this year, the lowest since the first quarter of 2005 when it was $199,700, the Chicago- based real estate trade group said.

The recent action in the U.S. stock market smells suspiciously like (yet) another buying panic.

But if buyers keep falling for the same routine over and over again, why stop now? Wall Street and hair-trigger speculators certainly have no reason to do so (pro-tip: if you think you're a hair-trigger speculator but don't have a team of PhDs working for you, you're probably not a hair-trigger speculator).

Long-term investors scrabbling to pick up those last few stocks before they're plucked off the market by private equity firms, on the other hand, might consider some basic economic principles first. Namely, that increasing demand and prices will have the same effect on the stock market as they do on any other market:

(Here comes the supply...)

First-quarter IPO proceeds hit seven-year, Q1 high

Initial public offerings in the United States turned in the strongest first quarter in seven years, according to a survey by PricewaterhouseCoopers. In the three months ended March 31, 64 IPOs raised $12.1 billion, up from 54 IPOs that raised $11.6 billion in the year-ago period. Scott Gehsmann, a capital markets partner in PricewaterhouseCoopers' Transaction Services group, cited strength in financial services and technology sectors, with financial sponsors continuing "to be a major factor in the market, backing 40% of all IPOs and raising 55% of proceeds."

"Stock prices never go down! (Well, OK they do, but they always come right back up.)"

Good Company

Well, if you’re going to be wrong about your “doom and gloom” worldview, at least it’s nice to be a member of an illustrious crowd that's growing by the day.

Anybody who’s relying on some risky asset (i.e. not cash) to fund their retirement would be well-advised to read this article, in my opinion. Nobody knows the future of course, but if you’re going to worry you might as well do so with the best of them.

Personal observation: Many people might find it comforting that U.S. stocks are soaring while the real economy deteriorates, but for fans of history this fact is a bit more hair-raising. We saw this same peculiar (and lethal) combination in the summer of 1929. Today the similarities are ignored because “Everybody Ought to be Rich”:

On Wall St: Something's Gotta Give waiting for last reel to unwind
May 11, 2007

If you are a film fan you could probably call it Apocalypse Later, while literary types might prefer Chronicle of a Crisis Foretold...

Investor gurus, banking chiefs, regulators and even private equity moguls are lining up to spread the word that the end is (almost) nigh.

The latest member of the furrowed-brow brigade is Ken Lewis, chief executive of Bank of America. On Wednesday, Mr Lewis provided a much-needed jolt of excitement at a meeting of the Swiss-American Chamber of Commerce with a call for "more sanity".

"We are close to a time when we'll look back and say we did some stupid things," he warned the Zurich-based great and good. He is, of course, absolutely right. As are KKR's Henry Kravis and Carlyle's David Rubenstein, the private equity titans who argue that their industry will not continue to have it so good forever. Familiar gloomy tones from legendary Cassandras such as Warren Buffett and Wilbur Ross only add to the general sense of unease.

These heady times of rocketing stock markets, gargantuan takeovers and supersized leverage just do not feel right...

http://www.msnbc.msn.com/id/18614260/

Addendum: People who cry wolf a lot ought to spend a lot of time around wolves.

Weighted Composite ISM Index for April 2007

Boilerplate: The intent of this graph is to show overall economic activity in the U.S. by combining the ISM Manufacturing and ISM Services indices into a single index weighted by the size of the corresponding sector. Values above 50 indicate growth. Values below 50 indicate temporary aberrations (such as bad weather), sample errors, outdated methodologies, or reporting bias. This data series is experimental and untested.

April 2007 Commentary

The index shows what appears to be a sharp rebound in U.S. economic activity. This may be an accurate reflection of reality, however in the past this series has been sufficiently noisy to make month-to-month changes largely useless for identifying new trends (the current trend is still decisively downward). In fact, in a hypothetical situation where the U.S. economy was heading into recession, it would probably be surprising not to see some false rebounds on the way down. April's uptick does make next month's data potentially more meaningful if it shows continued strength, though.

Note: This commentary is also experimental and untested.

Shanghai Melt-Up

I can't help thinking the Shanghai index is what Randall Forsyth had in mind when he used the term "moonshot" in a new Barron's article entitled Bubble 2.0.

The image is provocative, but some might argue that the performance of the Shanghai stock market is justified given the scorching 11% GDP growth that China is currently experiencing combined with a recent bear market. Note a previous high of 2242.42 six long years ago. Maybe 3841.27 is fundamentally justifiable.

I won't argue whether the fundamentals justify the price or not -- I haven't done the analysis. But I think to focus on the fundamentals is to miss a more significant point (I understand how ironic and misguided this sounds in the current environment):

Mechanically this type of behavior may be unsound. If a market is rocketing upward due to unsophisticated speculators and an extreme use of leverage, then the fundamentals may hardly matter in the short-term. Recall the 1987 U.S. stock market crash that occurred, in part, because the economy was too strong and the Fed felt compelled to raise interest rates. Also recall that in 1987 stocks were quite cheap by today's standards. Did the fundamentals justify a crash here? It seems harder to make that argument today.

With that out of the way, here's a link to another Randall Forsyth article that suggests maybe even the fundamentals aren't so great. At least for those shares available to U.S. investors:

Amid this frenzy for all markets foreign, some not surprisingly have become very expense. Based on their equity risk premium -- stocks' earnings yield relative to risk-free bond yields...

China's 2.8% earnings yield compares with a 3.6% bond yield, for a negative equity risk premium of minus 0.8%...

There's some admittedly contradictory data here, but one bit of useful and unambiguous information does stands out: we can safely add Randall "Moonshot" Forsyth to our growing list of stopped-clock permabear commentators and move on with life.

There seem to be a disturbing number of these types around nowadays.

U.S. Economic Sectors by Size and Composition

Here's some data I put together from various sources to create a rough overview of the structure of the U.S. economy. It's a first pass. The numbers are suspect. Service and Manufacturing industries add up to 92%, but what about the other 8%? How does the private/government breakdown below apply to specific industries above? Etc. Any insight or suggestions are welcome.

Service Industries (Non-Manufacturing)
80% of the US Economy

• Agriculture, Forestry, Fishing & Hunting
  
• Mining
  
• Utilities
  
• Construction
  
• Wholesale Trade
  
• Retail Trade
  
• Transportation & Warehousing
  
• Information
  
• Finance & Insurance
  
• Real Estate, Rental & Leasing
  
• Professional, Scientific & Technical Services
  
• Management of Companies & Support Services
  
• Educational Services
  
• Health Care & Social Assistance
  
• Arts, Entertainment & Recreation
  
• Accommodation & Food Services
  
• Public Administration

Manufacturing Industries
12% of the US Economy

• Food, Beverage & Tobacco Products
  
• Textile Mills
  
• Apparel, Leather & Allied Products
  
• Wood Products
  
• Paper Products
  
• Printing & Related Support Activities
  
• Petroleum & Coal Products
  
• Chemical Products
  
• Plastics & Rubber Products
  
• Nonmetallic Mineral Products
  
• Primary Metals
  
• Fabricated Metal Products
  
• Machinery
  
• Computer & Electronic Products
  
• Electrical Equipment, Appliances & Components
  
• Transportation Equipment
  
• Furniture & Related Products
  
• Miscellaneous Manufacturing (medical equipment and supplies, jewelry, sporting goods, toys and office supplies)

Private Sector
64% of the US Economy

Government Sector
36% of the US Economy

Consumer Spending
71% of the US Economy