Central Perk: Mish's Global Economic Trend Analysis

luni, 29 august 2011

Mish's Global Economic Trend Analysis

Battle Brews Over Texas Public Pensions, Group Seeks End of Defined benefit Plans
Value Restoration Project: Stock Market Valuations and Trends Over Time
US In Recession Right Here, Right Now

Battle Brews Over Texas Public Pensions, Group Seeks End of Defined benefit Plans

Posted: 29 Aug 2011 01:14 PM PDT

In a prelude for what will eventually happen in every state, a Battle brews over Texas public pensions.

Texas could be gearing up for its own Wisconsin-style grudge match over public employee benefits.

A group of high-powered Houston business leaders is starting a statewide campaign to overhaul retirement for future teachers, firefighters, police officers, judges and other state and local government workers.

"I think the state needs to get the hell out of this (pension) business completely," said lawyer Bill King , who is forming Texans for Public Pension Reform with others from the Greater Houston Partnership, an über-chamber of commerce with business members representing $1.5 trillion in assets.

Talmadge Heflin, former House appropriations chairman, agreed that it is probably too late for the pension reform group to be a major force in the 2012 elections.

But they could make waves during the 2013 legislative session, said Heflin, who has advocated for similar reforms as director of the Texas Public Policy Foundation's Center for Fiscal Policy.

Pension Haircuts Mandatory

Merely doing away with public defined benefit pension plans is insufficient. The article notes ...

In 2010, eight governors made pension reform a key campaign promise with the aim of cutting government spending and appealing to tea party supporters.

Yet not one has scrapped pensions this year in exchange for a 401(k)-style system, said Stephen Fehr, a researcher with the Pew Center on the States.

The problem is that states can't save money anytime soon by doing away with pensions.

In fact, it costs more in the midterm because taxpayers must contribute more to cover the benefits accrued by retirees and current workers because new workers would no longer be chipping in to the pension, Fehr said.

When a Texas Senate committee looked in 2008 at a similar pension conversion, the committee found no compelling reason to do so.

The state's Pension Review Board at the time estimated the combined contribution from the state and employees to the Employees Retirement System of Texas would have to rise from around 17 percent of payroll to as much as 30 percent if the pension were closed to new people.

In 30 years, the contribution rate would climb beyond 80 percent .

The first step is to stop the bleeding. The way to do that is to immediately kill defined benefit pension plans for all public employees.

The second step is to admit what has been promised cannot possibly be paid. Legislation that would allow public pension plans to go bankrupt may be needed.

Like it or not, one way or another, haircuts are coming. The sooner this is recognized and acted on, the smaller (and more equitable) the haircuts would be.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Value Restoration Project: Stock Market Valuations and Trends Over Time

Posted: 29 Aug 2011 10:59 AM PDT

I have written much about valuations of stocks recently, the bear market in stocks compression of PE ratios, and normalized earnings.

An associate, JJ Abodeely has been doing the same thing. His blog "Value Restoration Project" is dedicated to valuations and trends in valuations over time.

What follows is a JJ's most recent post in entirety, Are We There Yet? The Value Restoration Project Resumes

For readability purposes, I will not follow my normal "blockquote" process of quotes. What follows is from JJ, except where he quotes another source.

click on any chart in this post for sharper image

Are We There Yet? by JJ Abodeely

The declines in the stock market over the last three weeks have done a lot of damage to most investors' portfolios. This would merely be an inconvenience if it meant that future returns could be expected to be robust enough to compensate for the losses. In a July 22nd post which coincidentally, was the most recent top in the stock market, I suggested that "the conditions present in the market suggest that the Value Restoration Project in stocks, underway in fits and starts since 2000, will eventually resume."

Investors in the stock market may rightly be viewing this recent decline of about 12% over the last 16 trading days as a painful, but necessary, correction in prices which will once again bring value back to the market. After all, as I wrote in two recent missives, Expensive Markets Mean Low or Negative Prospective Returns and Denominators Matter

The fact is that what you pay matters and expensive markets today mean low or even negative prospective returns going forward. The value restoration project, which began with the peak of the stock market in 2000, is ongoing despite a 2 year cyclical rebound on the heels of unprecedented stimulus.

History however, suggests that market prices broadly will eventually resume declining relative to several denominators, in particular, normalized earnings and gold. Since late 2009, the market's gain has been of a very different nature– not only have stocks actually declined versus gold and other currencies, but they have been powered by normalized valuations going from expensive (19-20x) to more expensive (23x). This makes the gains over the last year or so particularly vulnerable.

So, in the spirit of Summer driving season and family road trips, the recent market decline begs the question, "Are we there yet"? Unfortunately, checking in with some important valuation indicators suggests the decline of the last several weeks has not accomplished enough to merit a more aggressive long-term portfolio stance.

Normalized P/E Ratio

For most of the Spring, the S&P 500 traded between 1300 and 1350 and sported a normalized P/E ratio of around 23x trailing 10 year earnings. In Expensive Markets Mean Low or Negative Prospective Returns I noted that when the cyclically adjusted P/E ratio is between 22 and 24 the average annual real returns (after inflation) for the subsequent 10 years is -2.2%, the median is-3.1% and the distribution looked like this

With the S&P's recent decline to 1178, the Cyclically-Adjusted or "Shiller" P/E has decline from a recent high of 23.6 to a somewhat more palatable 20.4. This begs the question of what sort of long-term returns have investors historically seen when the market P/E stood at similar levels as today?

There have been 125 monthly occurrences since 1881 when the normalized P/E ratio was between 19 and 21. The average annual real return with dividends reinvested over the subsequent 10 year period is about 1.6%, with roughly a third of the 10 year periods resulting in negative returns.

While somewhat more encouraging, these are hardly the returns that dreams are made of-- or financial planning assumptions, for that matter. For those who prefer to see their probable outcomes expressed in nominal returns, the average is about 4.5%.

A thorough understanding of history suggests that today's P/E level is still not low enough to warrant a buy and hold or passive approach to U.S. stocks broadly. As Ed Easterling of Crestmont Research is fond of saying, "secular market cycles are not driven by time, but rather they are dependent upon distance—as measured by the decline in P/E to a low enough level to then enable a significant increase."

Considering that the most recent secular market is starting from a spectacularly overvalued normalized P/E of 43.8x in 2000, we have quite a bit farther to travel.

Stocks Priced in Gold

Like a normalized earnings measure, adjusting stock market prices for the effects of a nearly constantly depreciating currency, allows us to assign deeper meaning to price. Please consider my recent post Denominators Matter! What the Price of Gold Tells Us About the Value of Other Assets.

The good news is the stocks prices have become even cheaper when adjusted for gold. Amazingly, the nominal price gains since the market low in March of 2009 have now been completely lost, when adjusted for gold. While this is mainly good news for those who own gold, it also gives us insight into the process by which the market is returning to a level where real, long-lasting value can be seen.

Fellow contrarians or disciples of mean reversion may think that this trend is poised to reverse, however a longer-term perspective is in order. We can easily see the secular bull and bear cycles from this chart which shows the Dow Jones Industrials Stock Index adjusted for gold since 1969. The 7x rise in gold since 1999, coupled with the nominal price decline in the Dow or S&P 500, has gone along way towards rectifying the imbalances in the valuation of the two asset classes. However, history suggests that durable, decade long, market bottoms are made at much lower levels.

No, we are not there yet

The recent sell off in the markets have been fast and furious and it would not be surprising to see stocks recover some of the recent losses in the weeks and months ahead. However, as John Hussman wrote in Two One-Way Lanes on the Road to Ruin

It is important to recognize that the S&P 500 is presently only about 13% below its April peak, and the word "only" deserves emphasis...The main problem here is that we essentially have nowhere constructive to go on the upside - advisory sentiment is already overbullish, and despite the recent decline, our 10-year total return projection for the S&P 500 has still only climbed to 5.1% annually. The ensemble of evidence remains steeply negative here.

This evidence most certainly includes the long-term valuation measure discussed here. Investors who take steps to protect their portfolios from the inexorable value restoration project will be in position to benefit from the next real bull market in stocks.

End Value Restoration Post

Everything from "Are We There Yet?" to "End Post" is from JJ Abodeely's Value Restoration Project. If you wish to contact him, you can do so with a button on his blog.

Here are my posts regarding valuations, value traps, and earnings.

February 07, 2011: Negative Annualized Stock Market Returns for the Next 10 Years or Longer? It's Far More Likely Than You Think

March 15, 2011: Anatomy of Bubbles; Negative Returns for a Decade Revisited; Is Gold in a Bubble?

June 20, 2011: Value Traps Galore (Including Financials and Berkshire); Dead Money for a Decade

August 17, 2011: Earnings Collapse Coming Up; Don't Worry Companies Will Still "Beat the Street"; Value Traps and Road to Ruin

August 23, 2011: Another "Lost Decade" Coming Up; Boomer Retirement Headwinds; P/E Expansion and Contraction Demographic Model; Negative Returns for a Decade Revisited

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

US In Recession Right Here, Right Now

Posted: 29 Aug 2011 12:54 AM PDT

I am amused by those who think a US recession will come within a year. Even more amusing are those who think a recession will not come at all.

The US is in a recession now. I am not the only one who thinks so.

Last Friday, I received an email from Rick Davis at Consumer Metrics, complete with an Excel spreadsheet that shows that had the GDP deflator been based on the consumer price index (CPI) rather than the BEA's measure of price inflation, the US would already be in the second quarter of contraction.

My friend Tim Wallace noted Davis' explanation would be consistent with Petroleum Distillates Demand Shows "Definite Economic Downturn Starting April/May 2011".

Thus Wallace was not surprised at all.

In the meantime, I received a set of emails from Doug Short. He had already charted what I was about to graph. Let's take a look.

The Deflator Makes Big a Difference

Please consider Will the "Real" GDP Please Stand Up? by Doug Short.

How do you get from Nominal GDP to Real GDP? You subtract inflation. The Bureau of Economic Analysis (BEA) uses its own GDP deflator for this purpose, which is somewhat different from the BEA's deflator for Personal Consumption Expenditures and quite a bit different from the better-known Bureau of Labor Statistics' inflation gauge, the Consumer Price Index.

I've updated my charts showing quarterly Real GDP since 1960 with the official and three variant adjustment techniques. The first chart is the official series as calculated by the BEA with the GDP deflator. The second starts with nominal GDP and adjusts using the PCE Deflator, which is also a product of the BEA. The third adjusts nominal GDP with the BLS (Bureau of Labor Statistics) Consumer Price Index for Urban Consumers (CPI-U, or as I prefer, just CPI). The forth chart, a recent addition prompted by several requests, adjusts nominal GDP using the Alternate CPI published by economist John Williams at shadowstats.com

The following charts are courtesy of from Doug Short.

Real GDP With GDP Deflator

Real GDP With CPI Deflator

Recession It Is

There you have it. That is what Tim Wallace spotted, that is what Rick Davis spotted, that is what Doug Short spotted.

No one really needed a chart for this.

I have been talking about a global slowdown for a long time. My only concern was if and when the NBER would agree to admit the obvious. I still do not know, but as I have stated before, I expect the NBER to backdate the recession to this quarter or next.

That is a guess, not a certainty.

Permanent Recession Since 1988?

Doug Short also produced a chart using the CPI as calculated by John Williams at ShadowStats. Here is that chart.

As much as I think GDP is nonsense (and I really do think it is nonsense, figuring the first 2% is hedonics and imputations), Williams carries the idea to ridiculous extremes.

Doug Short politely comments "I find this 'alternate Real' GDP to be interesting (in a freakish sort of way), but I personally see no credibility in the hyper-negative GDP is produces."

"Freakish" Hyperinflation Report

Please consider Williams' Hyperinflation Special Report (Update 2010)

Risks are high for the hyperinflation beginning to break in the year ahead; it likely cannot be avoided beyond 2014.

It is this environment of rapid fiscal deterioration and related massive funding needs, the U.S. dollar remains open to a rapid and massive decline and to the dumping of U.S. Treasuries. The Federal Reserve would be forced to monetize significant sums of Treasury debt, triggering the early phases of a monetary inflation. Under such circumstance multi-trillion dollar deficits rapidly would feed into a vicious, self-feeding cycle of currency debasement and hyperinflation.

Hyperinflation When?

That was written in 2009 with an update in 2010.

Amusingly in the Hyperinflation Special Report (2011) William comments on his timeline for hyperinflation.

Outside timing on the hyperinflation remains 2014, but there is strong risk of the currency catastrophe beginning to unfold in the months ahead. It may be starting to unfold as we go to press in March 2011, but moving into a full blown hyperinflation could take months to a year, beyond the onset, depending on the developing global view of the dollar and reactions of the U.S. government and the Federal Reserve. ...

The federal government and Federal Reserve's actions in response to, and in conjunction with, the economic and financial crises of 2007, however, accelerated the ultimate process—both in terms of fiscal deterioration and global perception of the issues—moving the outside horizon for hyperinflation from 2018 to 2014.

Even so, over the last year or two, the government and Fed's actions and policies, and economic and financial-market developments have continued to exacerbate the circumstance, such that there is significant chance of the early stages of the hyperinflation breaking in the months ahead. Key to the near-term timing remains a sharp break in the exchange rate value of the U.S. dollar, with the rest of the world effectively moving to dump the U.S. currency and dollar-denominated paper assets.

Williams Fails to Understand

Debt-deflation
The role of credit vs. money
Flight to cash
The significance of trillions of dollars in excess reserves just sitting there because banks are undercapitalized and there are to few credit-worthy borrowers
How little power the Fed has in controlling the demand for credit (and thus inflation)
How international trade works

Breathtaking Ignorance

That is a heck of a lot of things to not understand, but let's focus on one critical error namely Williams' statement "the rest of the world effectively moving to dump the U.S. currency and dollar-denominated paper assets".

I have commented on the invalid nature of such statements at least a dozen times. Here is one from a week ago in Michael Pettis: Long-Term Outlook for China, Europe, and the World; 12 Global Predictions

Via email, Michael Pettis at China Financial Markets shared his outlook for China, Europe, and the world. The overall outlook is not pretty, and includes a breakup of the Eurozone, a major slowdown for China, and a smack-down of the much beloved BRICs.

Pettis Writes ...

August is supposed to be a slow month, but of course this August has been hectic, and a lot crueler than April ever was. The US downgrade set off a storm of market volatility, along with bizarre concern in the US about whether or not China will stop buying US debt and the economic consequence if it does, and equally bizarre bluster within China about their refraining from buying more debt until the US reforms the economy and brings down debt levels.

What both sides seem to have in common is an almost breathtaking ignorance of the global balance of payment mechanisms. China cannot stop buying US debt until it engineers a major adjustment within its economy, which it is reluctant to do. Until it does, any move by the US to cut down its borrowing and spending will trigger a drop in global demand which will cause either US unemployment to rise, if the US ignores trade issues, or will cause Chinese unemployment to rise, if the US moves to counteract Chinese currency intervention.

Emphasis in red added.

Just the Math Ma'am

What Pettis states, and I have reiterated at least a dozens time is that as long as the US runs a trade deficit, US treasuries will have a bid.

This is not speculation, the statement is a near mathematical certainty. Moreover, the US Would Welcome China Not Buying US Treasuries! exactly the opposite of what hyperinflationists would have you believe.

Please read the link for a detailed explanation.

Yield Curve as of 2011-08-28

As the silly calls for near-term hyperinflation mount, I point out a chart of the yield curve.

click on chart for sharper image

Does that look like hyperinflation or does it look like deflation?

Back to the Real World

In the real world, Doug Short comments on Real GDP Per Capita, Year-over-Year Change, and the Next Recession

The next chart shows the YoY change in real GDP from the earliest quarterly data in 1947. I've again highlighted recessions. The red dots show the YoY real GDP for the quarter in which the recession began. The blue dot shows the latest YoY real GDP. Note: Unlike the previous chart, this one does not include a per-capita adjustment.

As the chart illustrates, the latest YoY real GDP, at 1.5%, is below the level at the onset of all the recessions since the first quarterly GDP was calculated — with one exception: The six-month recession in 1980 started in a quarter with lower YoY GDP (1.4% versus today's 1.5%). And only on one occasion (Q1 2007) has YoY GDP dropped below 1.5% without a recession starting in same quarter. In that case the recession began three quarters later in December 2007.

In his 2011 Jackson Hole speech, Chairman Bernanke observed that "growth in the second half looks likely to improve." Our look at YoY GDP percent change suggests that we must indeed see stronger second half growth to avoid the recession that now appears to be a high-probability risk. If Q3 real GDP shows a continuation of the current trend, the NBER will likely pick a month in Q2 as the beginning of a new recession.

Unless there is an immediate pickup in GDP, highly doubtful given Hurricane Irene, the NBER will backdate the recession to the second quarter, just as Tim Wallace stated.

Some analysts will blame Irene. If so, it will be just another "bullshill" excuse by analysts to avoid admitting they blew it. Bernanke may try the same ploy. If so, it will be an attempt to buy time, hoping for a miracle.

No miracles are on the horizon.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

luni, 29 august 2011

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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luni, 29 august 2011

Mish's Global Economic Trend Analysis

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