Central Perk

sâmbătă, 12 decembrie 2015

Seth's Blog : When things go wrong

When things go wrong

A protocol for moving forward:

0. Double check the work to make sure that there are no other problems within it.

1. Alert the relevant parties

2. Take responsibility for what went wrong. This doesn't mean that you intentionally did it wrong, or that doing it right was part of your job description. It means that you know something went wrong, you're unhappy about it, and you accept responsibility for letting it get by you and you accept responsibility for making sure it won't happen again.

3. Apologize. Not because it's your fault, but because the incident cost other people time or money or upset them, and you're sorry that they have to deal with that.

4. Come up with a plan to ameliorate the impact of the problem. If you can't come up with a plan, say so and ask for suggestions.

5. Come up with a plan to avoid the problem in the future.

6. Gather feedback.

7. Thank everyone for their patience and goodwill.

Either that, or you could hide, dissemble, blame, shuffle along, scowl, depersonalize and then move on.

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vineri, 11 decembrie 2015

Mish's Global Economic Trend Analysis

Stocks More Overvalued Now Than 2000 and 2007 No Matter How You Look at Things
How to Uncover Hidden Economic Weakness!
Retail Sales Soft Again (Unless You Exclude Everything Weak); How to Uncover the Hidden Consumer Strength!
Federal Spending Per Full Time Workers and Related Charts

Stocks More Overvalued Now Than 2000 and 2007 No Matter How You Look at Things

Posted: 11 Dec 2015 01:18 PM PST

Overvalued No Matter How You Look

Currently, stocks are extremely overvalued by multiple methods.

The first way is by looking at Cyclically Adjusted P/E Ratios commonly known as CAPE, Shiller P/E, or P/E 10 ratio.
The second is by looking at median P/E and P/S (Price to Sales) measures

We will look at both, but here's a description of CAPE.

CAPE is a valuation measure applied to stock market indexes. It's defined as price divided by the average of ten years of earnings (Moving average), adjusted for inflation. The essential idea is earnings are mean-reverting making forward looking earnings frequently too optimistic, and current PEs too high following steep corrections.

CAPE is not without its detractors and debates have raged over its usefulness recently, just as they do at every major market peak when investors find all sorts of silly reasons to presume "It's different this time".

Stocks More Overvalued Now Than Ever

I will post a CAPE chart in a bit, but for now let's take a look at another PE measure I first saw described today.

The idea is from Ned Davis, but written up by Mark Hulbert in Opinion: Stocks are more overvalued now than at 2000 and 2007 peaks.

Median NYSE Stock's Current P/E and P/S Ratios Sparks Concern

The stock market currently is even more overvalued than it was at the bull market peaks of both March 2000 and October 2007 — according to not just one, but two, valuation measures.

That at least is the message of an analysis released earlier this week by Ned Davis Research, the quantitative research firm. What caught my eye in the firm's analysis was that, unlike virtually all others that conclude that stocks are overvalued, this one was not based on the so-called Shiller P/E — the cyclically-adjusted P/E ratio championed by Nobel laureate Robert Shiller of Yale University.

That's noteworthy, since there would be nothing new in reporting that Shiller's P/E shows stocks to be overvalued. That ratio has been giving this same message for several years now, and skeptics have found many ways of wriggling out from underneath its bearish implications.

But Ned Davis's latest report focuses on something different: the median stock's price/earnings and price/sales ratios. The median stock, of course, is the one for which exactly half have higher ratios and half have lower. By focusing on the median, Davis's findings are immune from the charge that they are being skewed by outliers — such as the terrible earnings among energy companies.

The chart at the top of this column summarizes what Davis found. Currently, according to his firm's research, the median NYSE-listed stock has a price/earnings ratio of 25.6, when calculated based on trailing 12-month earnings. At the bull market peak in October 2007, for example, the comparable ratio was below 20; at the top of the Internet bubble in March 2000, it was even lower.

In fact, according to Davis, the price/earnings ratio currently for the median NYSE stock is the highest it's ever been since his data series began in 1980 — except for the bear-market lows of October 2002 and March 2009, when earnings were depressed by recessions.

A similar story is told by the price/sales ratio. The median S&P 500 SPX stock currently has a ratio of 2.16, according to Davis, versus 1.9 in October 2007 and even lower in March 2000. The median stocks' price/sales ratio has never been higher than it's been this year.

Stocks Incredibly Expensive

To me this is a nice confirmation of what I already know: that stocks are incredibly expensive. Renown investor Jeremy Grantham at GMO feels the same way.

And GMO's Ben Inker makes a strong case that US equities do not deserve much of a PE premium as noted in Disastrous Discussion: US Corporate Profits vs. GDP: How Sustainable is Corporate Profit Trend? Do US Equities Deserve a PE Premium?

How bad can it get?

Inker suggests real (after inflation) earnings may range between -4% and +2% every year for seven years, on US large equities, depending on profit margins vs. assumptions. Yes, a 4% real loss every year for seven straight years is a possibility.

Inker does not put odds on any particular number but here is their actual current best guess.

GMO 7-Year Asset Class Real Return Forecasts

The above from latest GMO Forecast.

GMO Disclaimer

The chart represents real return forecasts for several asset classes and not for any GMO fund or strategy. These forecasts are forward‐looking statements based upon the reasonable beliefs of GMO and are not a guarantee of future performance. Forward‐looking statements speak only as of the date they are made, and GMO assumes no duty to and does not undertake to update forward‐looking statements. Forward‐looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results may differ materially from those anticipated in forward‐looking statements. U.S. inflation is assumed to mean revert to long‐term inflation of 2.2% over 15 years.

I point out that a 0% for seven years would be disastrous for pension funds expecting 8% returns or better for the same timeframe.

With that let's return to CAPE.

Shiller PE Ratio

The above chart from Shiller-PE. The chart is continually updated.

I added the dashed red lines. Stocks at or approaching the upper red line are in the warning zone. That does not mean a crash is imminent. Things can stay overvalued for years.

Stocks at or below the bottom line are cheap, but they can always get cheaper. Note that in 2000 crash stock did not even drop in the value zone. They did in the 2007-2009 crash, but never reached the point of exceptional value.

In contrast to the Ned Davis median PE valuation method which only looks at current PEs, Shiller-PEs will drop following a crash.

I see viability in both models, you just need to understand what you are looking at. And right now they are pretty much screaming the same thing, at least to me: sell.

Mike "Mish" Shedlock

How to Uncover Hidden Economic Weakness!

Posted: 11 Dec 2015 09:16 AM PST

Having just written How to Uncover the Hidden Consumer Strength!, I think it's only fair to see if there is a way to uncover hidden weakness.

Business inventories provide a method. The consensus estimate for month-over-month changes in inventories was +0.1% but the actual change was 0.0%.

To see if we can spot the weakness, let's once again start with analysis from a Bloomberg Econoday report, this time on inventories.

Businesses appear to be putting the brakes on inventories which however are still rising a bit relative to sales. Business inventories were unchanged in October with September revised down 2 tenths to plus 0.3 percent in readings that will pull down the GDP outlook slightly. Sales came in unchanged which is just enough to drive up the stock-to-sales ratio to 1.38 from 1.37. This time last year, this reading was at 1.31.

All three components show only the most minimal change in inventories, up 0.1 percent for retailers and down 0.1 percent for both manufacturers and for wholesalers. And sales tell the story, unchanged in October for both retailers and wholesalers and down 5 tenths for manufacturers.

The lack of punch in the economy, the result of weak foreign demand, continues to put upward pressure on inventories. But businesses are successfully keeping their stocks as low as possible, thereby limiting future corrections in production and employment.

Success in Pictures

I don't know about you, but I am absolutely delighted to learn "businesses are successfully keeping their stocks as low as possible, thereby limiting future corrections in production and employment."

Problem Vanishes

I thought I spotted a problem on December 9 as detailed in Wholesale Trade: Another Bad Report: What About Autos?

Inventories to Sales

The inventory-to-sales ratio is clearly in the danger zone. Over-optimism across the board is generally what causes these spikes.

Year-on-year, inventories are up 3.6 percent but sales are down 3.7 percent. Inventories contributed heavily to rather anemic GDP growth this year.

Inventory and Sales - Percent Change From Year Ago
Group Sales Inventories Sales-to-Inventory Ratio Current Sales-to-Inventory Ratio Year Ago
US. Total -3.7 3.6 1.31 1.22
Durable -2.2 2.5 1.66 1.58
Automotive 2.3 13.1 1.77 1.6
Furniture 6.4 9.9 1.63 1.58

Take a good look at autos. Sales are up 2.3 percent but inventories are up 13.1%. Across the board, inventories-to-sales seem way out of line.

Today, I learn there is no problem because inventories are as lean as they can possibly be.

So, I have to apologize. There are no weaknesses, hidden or otherwise. There are only "hidden strengths".

Please click on the link at the top to discover how Bloomberg can guide you to the proper way to unhide those hidden strengths.

Mike "Mish" Shedlock

Retail Sales Soft Again (Unless You Exclude Everything Weak); How to Uncover the Hidden Consumer Strength!

Posted: 11 Dec 2015 08:33 AM PST

Retail sales disappointed once again today. And for the second month in a row, autos led the decline.

Last month retail sales rose 0.1%. This month retail sales rose 0.2% vs. a Bloomberg Consensus Estimate of a 0.3% rise. Nonetheless, Bloomberg analysts cite hidden strength.

Hidden Strength?

Once again the headline for the retail sales report understates underlying strength. Total retail sales rose only 0.2 percent in November which is just under the Econoday consensus. But weakness here came from vehicles of all places which otherwise have been one of this year's standout component for this report. Excluding vehicles, sales rose 0.4 percent which is 1 tenth above expectations. Excluding both vehicles and gasoline, core sales rose a very solid 0.5 percent which is 2 tenths above expectations. A key discretionary category, restaurants, shows yet another very strong gain, this at 0.7 percent in the month. Also showing sizable gains are electronics & appliances, clothing & accessories, non-store retailers (once again), and the general merchandise category where, despite a deflationary pull from falling import prices, sales jumped 0.7 percent in the month.

Vehicle sales fell 0.4 percent in the month on top of October's 0.3 percent decline. These declines are a bit of a surprise given steady readings in unit sales of vehicles which have been holding firmly at 12-year highs. Whether there's a rebound ahead for vehicle sales, which had been so strong through the year, will be key to consumer spending going into the new year. Sales at gasoline stations continue to contract, at minus 0.8 percent in the month. Furniture sales, which have been strong, fell back as did sales of building materials & garden supplies, which have been soft.

Year-on-year rates show nonstore retailers out in front, at plus 7.3 percent to confirm acceleration for online sales. Restaurants are right behind at plus 6.5 percent year-on-year followed by furniture and by sporting goods, both at plus 5.4 percent. All together, core retail sales are up a moderate 3.6 percent year-on-year held down by contraction in electronics & appliances and soft readings for grocery stores and general merchandise. Outside the core, motor vehicles are still in the thick of things, at plus 4.0 percent year-on-year, with gasoline stations down 19.9 percent. Total retail sales are up only 1.4 percent but the gain goes up to 3.6 percent (the same as the core) when excluding just gas.

Taken together, rates of growth are no more than moderate but certain areas are posting eye-catching results, results that point to what must have been a successful Black Friday sales push. The consumer, boosted by a solid labor market and having more money to spend because of low gas prices, is definitely alive and spending going into the final weeks of the holiday season. In a methodology note, the November data reflect a new sample and prior levels have been revised (mostly lower).

Exclusionary Process

It amusing how much analysts go out of their way to ignore everything bad in a report. Take the case of autos. All year, autos have been one of the leading retail sales components. For the last two months they haven't. Earlier this year, analysts were cheerleading autos, today they say ignore autos.

While we are at it, let's exclude gas. If we ignore gas, retail sales are up 3.6%, but only up 1.4% including gas. That's obviously a strong case right there for ignoring gas.

Last month, on November 13, I reported Retail Sales Weaker Than Expected, Led by Autos; Car Boom Ending?

Here are my lead paragraphs from a month ago.

This month the retail sales consensus expectation was for a 0.3% rise.

The actual reading was a gain of just 0.1% for the month. In addition, last month's retail sales were revised lower to +0.0% from an initial reading of +0.1%.

This was the third consecutive weak report.

Nonetheless Bloomberg managed to put an amazing amount of lipstick on today's report.

This is how Bloomberg analysts saw things on November 13:

Bloomberg: "Retail sales slowed in October but fundamentally remain solid. Sales rose only 0.1 percent, 2 tenths under the Econoday consensus. But when excluding vehicles, which slipped back after surging in prior months, and when also excluding gasoline stations, where sales once again fell on price weakness, core sales rose a respectable 0.3 percent which hits the consensus."

What did Bloomberg say in September?

I just happen to have that answer in my September 15, report Retail Sales Rise Thanks to Autos; Industrial Production Sinks Thanks to Autos; Last Hurrah for Autos?

Bloomberg: "Turning first to strength in the August data, motor vehicles rose 0.7 percent on top of July's 1.4 percent gain. These are very solid readings for a very important component that points squarely at a healthy and confident consumer."

In September autos pointed "squarely at a healthy and confident consumer". Obviously we need to include autos in our September analysis.

What did Bloomberg say in October?

I happen to have that answer in Autos and Restaurants Positive in Overall Weak Retail Sales Report; Last Month's Sales Revised Lower.

Bloomberg: "And there are plenty of tangible positives in the data including a third straight solid gain for motor vehicles, at plus 1.7 percent in September, and a second straight outsized gain of 0.9 percent for restaurants. Both of these are discretionary categories and point to underlying consumer strength. Clothing stores are also posting strong gains, up 0.9 percent despite negative price effects from lower import prices."

Four Months of Hidden Strength

Autos don't matter now, and they won't until they will. They will the next time autos rise. Gasoline sales never matter until gas prices start to rise again, and then they will.

Uncover the Hidden Strength!

I suggest Bloomberg uncover what's hidden and produce a chart that shows the strength. All they have to do is strip out those things that sometimes matter and sometimes don't, while always removing things that never matter, until of course they do.

Then the strength will no longer be hidden and everyone will be happy.

Questions to Ponder

Is it good for GDP that people are buying junk (likely from overseas), instead of autos which are likely to be domestic?

Have autos peaked? I think so.

Mike "Mish" Shedlock

Federal Spending Per Full Time Workers and Related Charts

Posted: 11 Dec 2015 12:57 AM PST

Reader Tim Wallace sent in another series of interesting charts showing the existing trends in employment, government spending, population, and labor force. Click on any chart for a sharper image.

Federal Spending Per Full Time Worker

In 1968, the US government spent $2,734 per every full time worker. By 2015, the amount soared to $30,834. Had spending per full time worker increased at the rate of inflation, it would have been $19,390.

Full Time Employment as Percentage Population

Employment as Percentage Population

Labor Force as Percentage of Population

Work Force Data

Fewer and fewer workers are supporting more and more retires. Military spending, Medicare, Medicaid, and other entitlement costs have soared out of sight and not about to stop. In addition state pensions are a disaster area in spite of the massive stock market rally.

Millennials have now taken over as the largest demographic group but they cannot possibly pick up all the associated costs. Something has to give.

Mike "Mish" Shedlock

Seth's Blog : Light on your feet

Light on your feet

To walk lightly through the world, with confidence and energy, is far more compelling than plodding along, worn down by the weight on your shoulders. When we are light on our feet we make better decisions, bring joy to those around us and find the flexibility to do good work.

There are two ways to achieve this.

The first is take the weight away. To refuse to do work that's important. To not care about the outcome. Whatever.

The second is to eagerly embrace the weight of our commitment but to commit to being light, regardless. This is the surgeon who can enjoy doing brain surgery, not because surgery isn't important, but because it is.

The work is the work, regardless of whether you decide to be ground down by it.

It might be tempting to try to relieve yourself of responsibility, but it's a downward spiral, a path to banal industrialism. Better, I think, to learn to dance with it.

To take it seriously, not personally.

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joi, 10 decembrie 2015

Mish's Global Economic Trend Analysis

Attitudes, Attitudes: Dear Nate Silver, Regarding Donald Trump, You Are Missing Something Big!
Disastrous Discussion: US Corporate Profits vs. GDP: How Sustainable is Corporate Profit Trend? Do US Equities Deserve a PE Premium?
Import/Export Price Deflation: Export Prices -0.6%, Double Consensus Estimate; Import Prices -0.4% Half Estimate; Net Negative for GDP
Truck Rates Plunge; What About Actual Shipping Volumes? Strong Case for Pending Recession

Attitudes, Attitudes: Dear Nate Silver, Regarding Donald Trump, You Are Missing Something Big!

Posted: 10 Dec 2015 07:57 PM PST

I am a big fan of Nate Silver. He was spot on in the last two presidential elections and I bought into his methodology, in advance, confidently predicting the results.

Nate adjusted his odds as the campaign progressed and got 49 out of 50 correct in 2008.

I am not sure which one he missed, but I got 49 out 50 correct before Obama even won the nomination. Missouri showed me up.

Initially, my methodology was quite a bit different. I was certain the economy was headed for disaster and that every remotely close state would swing Democratic. It was that simple for me, but I became a huge fan of his methodology as the election campaign progressed.

Nate got all 50 right in 2012. I missed a couple. But I made my picks early in a bragging rights bet with friends. Had I predicted in the final week, I likely would have just gone with Silver's picks or his methodology for the same outcome.

So yes, I am a fan. Yet, I have to say "Dear Nate, you are missing something big time!

Polls Relevant?

Week after week Donald Trump surges in the polls, and week after week Silver says ignore them.

I say you can no longer ignore them. I will explain why below. First let's look at how Nate sees things.

August 6: In Donald Trump's Six Stages Of Doom Nate Silver said "I recently estimated Trump's chance of becoming the GOP nominee at 2 percent. How did I get there? By considering the gantlet he'll face over the next 11 months — Donald Trump's Six Stages of Doom."
September 15: Nate Silver said Trump Has About 5% Chance Of Winning
October 20: In Donald Trump Is Doomed And/Or Invincible Nate Silver again referred to Six Stages of Doom saying "Trump's odds are in the high single digits... and on September 1 his chances were 2%". Adding "nobody quite like Trump has won a party nomination before, or even come all that close to it. So there's some universe where his chances are 0 percent. .... to some extent 4 percent vs 7 percent is an angels-dancing-on-pinheads debate."
November 23: In Dear Media, Stop Freaking Out About Donald Trump's Polls Nate Silver said "Trump's chances are higher than 0 but (considerably) less than 20 percent".

South Carolina Poll

Here are results from a South Carolina Poll released December 9.

Trump 35%
Carson 15%
Cruz 14%
Rubio 14%
Bush 5%
Graham 2%

Support for Trump rose 8 points after his statement he would bar Muslims from entering the US. Graham is from South Carolina.

Five Key Points

39% have national security as their top issue.
29% prioritize economic issues.
16% say immigration is the top issue.
Among voters with national security as the top issue, trump has 32%, double that of anyone else.
Trump has a 48% landslide result on the economy.

Would Trump Bolt?

In a USA Today poll releases December 8, 68% of Trump's supporters would vote for him if he bolts the GOP.

That's one hell of a lot of loyalty. Do I believe that? No. But, that is a strong measure of strong sentiment.

Nearly Two-Thirds Of Likely GOP Voters Back Trump's Muslim Ban

A Talking Points Memo reports Nearly Two-Thirds Of Likely GOP Voters Back Trump's Muslim Ban.

Republican presidential frontrunner Donald Trump's recent proposal to ban all Muslims from entering the U.S. has far from hurt his poll numbers; in fact, a poll released Wednesday found that almost two-thirds of GOP primary voters back the widely-condemned plan.

In a new Bloomberg Politics/Purple Strategies poll, 37 percent of all likely general election voters said they support Trump's plan while 65 percent of likely Republican primary voters said they back the ban.

Attitudes

The role of attitudes is precisely what Silver misses. Opinions of candidates can come and go. But are the attitudes towards banning Muslim's likely to change?

What Inning Is It?

Silver says "campaign time is not linear. We're still in the functional equivalent of the top of the second inning."

Is it the 2nd inning or the 3rd? Either way, I would agree with Silver that it's early. But what is the lead? Is it no runs, one run, or perhaps as many as four runs?

What About Undecideds?

Silver points out the vast majority of people make up their minds in primaries late in the game but voters make up their minds earlier in national elections. That makes sense, because there are only two candidates to choose from in the election, and primarily it's only the independents who swing.

But is it really as lopsided as Silver suggests below?

I suggest that table is a poor reflection of reality. For starters, I doubt there are truly 80% undecided, but for the sake of argument I will accept that number.

The chart is unrealistic because although voters may be undecided, it likely they are undecided between two or at most three candidates, not totally clueless.

For example some voters may be undecided between say Trump and Carson one week, and Trump and Rubio the next, while totally ruling out Bush, Fiorina, Huckabee, and Christie.

So, there's undecided, and there's totally clueless.

Stubborn Facts

Silver concludes his "Dear Media, Stop Freaking Out About Donald Trump's Polls" article with ...

So, could Trump win? We confront two stubborn facts: first, that nobody remotely like Trump has won a major-party nomination in the modern era. And second, as is always a problem in analysis of presidential campaigns, we don't have all that many data points, so unprecedented events can occur with some regularity. For my money, that adds up to Trump's chances being higher than 0 but (considerably) less than 20 percent. Your mileage may vary. But you probably shouldn't rely solely on the polls to make your case; it's still too soon for that.

More Stubborn Facts

Trump has stayed on top of the polls far, far, longer than anyone including Silver and I thought possible. I even wondered if his anti-Muslim talk would sink him. It didn't. For now it seems to have strengthened him.
Everyone's up-front favorite, Jeb Bush is burning money like mad.
Bush is getting trounced even his home state.
Carson is sinking like a rock. Since Carson is an unconventional candidate, history suggests he is now a lost cause.

Opinions

Do Christie, Paul, Fiorina, Huckabee have any chance? I suggest close to zero but let's put them at 1% each. Let's generously put Bush at 5%.

Although it's highly doubtful Carson can recover, let's Generously put Carson at 5%

Now what do we have?

Revised Support Suggestion

Which Way Will Undecideds Break?

Are those undecideds really likely to vote for anyone other than Trump, Carson, Cruz, or Rubio?

Come on Nate, really?

Put Bush in the list if you want but even Carson in the swing is generous. I suspect Carson will lose more of what he has now than pick up new undecided voters.

Bush can pick up undecideds. That's why I raised Bush to five from Nate's one.

Even if most have not decided who they will vote for, it's highly likely those voters have decided one or more candidates they won't vote for. And that matters.

Based on attitudes, Trump for now, clearly belongs in the "possible list" of a huge percentage of those undecided voters!

By the way, I'm not really talking about just Iowa above, but rather national numbers. The results of the first few primaries will be the tell.

Looked at this way, even though it's only the second or third inning, the odds of Trump winning would seem to be no worse than about 25%.

But are they better?

Of course they are. Attitudes are the key. 65 percent of likely Republican primary voters said they back the ban on Muslim immigration!

Key Questions of the Day

Is there a choice of candidates if that's how one feels about Muslims?
Is that attitude going to change?
And what about those five key points above?

Those five key points above are about voter attitudes as well. This means Trump's strong attitudes on Muslim's and immigration are aligned with strong voter attitudes on the same issues.

Importantly, no other candidate has those attitudes!

So unless Trump sticks his foot in his mouth on some issue, attitudes may be enough for him to carry the day. And while anything can happen, some things are far more likely than others.

Nate, care to rethink your odds?

Mike "Mish" Shedlock

Disastrous Discussion: US Corporate Profits vs. GDP: How Sustainable is Corporate Profit Trend? Do US Equities Deserve a PE Premium?

Posted: 10 Dec 2015 10:34 AM PST

US Corporate Profits vs. GDP

The latest GMO Quarterly Report, released yesterday as a 26-page PDF, has some interesting charts and commentary on valuations, PEs, and a premium on US equities.

Let's put a spotlight on a chart and commentary starting on page 10.

When we began building our forecasts, this series had a wonderfully mean-reverting look to it. There had been no obvious trend for the close to 50 years of data, despite plenty of good times and bad in the interim. And the appearance of long-term stability still seemed strong as late as the early 2000s. At the time we excused the new highs of profitability as the consequence of the housing boom and bubble in risk assets. Afterwards profits were good enough to fall through the old average in the financial crisis, although not to the lows we saw in prior recessions. And since then, after the fastest and sharpest recovery on record, we saw them rise well beyond anything the U.S. has ever seen. On this measure, while profitability is off of its recent highs, it is higher than any point in history before 2010.

And this leads to the quandary for thinking about the U.S. stock market. We cannot find any convincing evidence that the U.S. is deserving of trading at a premium P/E to the rest of the world. This profitability, however, could be read either of two ways. Either the U.S. has somehow unlocked a secret to permanently higher profitability or this is an extremely dangerous time to be investing in the U.S. U.S. profitability has never looked materially better relative to the rest of the world than it does today. The bull case would be that, for whatever reason, this profitability gap is sustainable and U.S. stocks are only mildly more expensive than the rest of the developed world given U.S. P/Es are only about a point higher.

But, frankly, we have a hard time believing this bull case. U.S. outperformance in recent years can be readily explained by the better trends in profitability, but that is a long way from saying that outperformance was truly justified. From a macroeconomic perspective, maintaining such high levels of profitability in the face of low investment rates implies ever-increasing wealth inequality in this country, unless taxes were to be raised in a way that seems highly implausible. Generating sufficient end demand in the economy given the inequality would call on either the rich to start spending their wealth at significantly greater rates than we have seen historically or the rest of households to spend more than 100% of their income, as they did in the housing bubble. It is hard to envision that an economy that relies on those foundations to be a sustainable one.

Conclusion

The clearest evidence for the U.S. being special today is inextricably tied to its recent performance. In the long run, the U.S. clearly had the good fortune of not having its capital stock destroyed, but otherwise doesn't look that special. In the shorter term, we have seen an impressive expansion of American profitability that has not been mirrored in the rest of the world, and U.S. stocks have duly outperformed. This has, not surprisingly, led investors to try to convince themselves of the inherent superiority of U.S. stocks to justify continuing to hold them. We cannot completely reject the possibility that those arguments are correct, but the evidence seems pretty thin. Certainly there is no strong evidence that would cause us to believe the U.S. is truly deserving of trading at a higher P/E than the rest of the world. On the profitability front, there seems little doubt U.S. corporate profitability is better than normal, but the question is how much better? Our best estimate is that profit margins are about 24% better than normal, but there is a wider than normal range of possibilities here, with the plausible figures anywhere from 5% to 40% above normal. The impact on our forecast is a range as high as +2% real to a disastrous -4% real for the next seven years, depending on which measure of profitability was the "true" one.

Disclaimer: The views expressed are the views of Ben Inker through the period ending December 2015, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.

Questions

How Sustainable is Corporate Profit Trend?
Do US Equities Deserve a PE Premium?

1A. I side with Ben Inker that US equities do not deserve much of PE premium.

2A. As far as profitability goes, ignoring another massive war such as WWII, the US cannot hold an edge in profitability for long. Aside from labor issues and tax consequences, whatever US companies are doing better productivity-wise, other companies will eventually figure out.

But that statement does not really answer the question of trend. Even if the US deserves a premium, the trend itself will mean revert.

Simply put, corporate profits as a percentage of GDP are not going to stay in the 9% to 10% range, and 10-year smoothed PEs will not stay at a level they are now, only exceeded in 1929, 2000, and 2007.

There is no reason to believe "this time is different" for either PEs or corporate profits.

Here's the critical question: If the trends mean revert, what will US equities return?

7-Year Asset Class Real Return Forecasts

The above from latest GMO Forecast.

GMO Disclaimer

The chart represents real return forecasts for several asset classes and not for any GMO fund or strategy. These forecasts are forward‐looking statements based upon the reasonable beliefs of GMO and are not a guarantee of future performance. Forward‐looking statements speak only as of the date they are made, and GMO assumes no duty to and does not undertake to update forward‐looking statements. Forward‐looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual results may differ materially from those anticipated in forward‐looking statements. U.S. inflation is assumed to mean revert to long‐term inflation of 2.2% over 15 years.

How Good or Bad Can Returns Get?

I like Inker's approach of putting a range on things. Here is the key paragraph from above:

Our best estimate is that profit margins are about 24% better than normal, but there is a wider than normal range of possibilities here, with the plausible figures anywhere from 5% to 40% above normal. The impact on our forecast is a range as high as +2% real to a disastrous -4% real for the next seven years, depending on which measure of profitability was the "true" one.

Disastrous Discussion

Inker labeled -4% real returns as "disastrous". Actually, 0% for seven years would be disastrous for pension funds expecting 8% returns or better for the same timeframe.

States like Illinois would likely be wiped out. And if 0% is disastrous, I am not sure what the correct word for -2% or -4% should be.

Even 2% real returns (3%-4% nominal) vs. expected nominal returns of 8% or better would be an outright disaster to many pension plans. Yet, 2% is likely as good as it gets.

Looking back on today, seven years from now, Inker may very well look like an optimist.

Mike "Mish" Shedlock

Import/Export Price Deflation: Export Prices -0.6%, Double Consensus Estimate; Import Prices -0.4% Half Estimate; Net Negative for GDP

Posted: 10 Dec 2015 08:27 AM PST

Import/Export Price Deflation

Import/export price deflation continues in November. The kicker this month is a decline in exports prices greater than the decline in import prices with agricultural products leading the way, down a steep 1.1%.

The Bloomberg Econoday consensus estimate was for export prices to dip -0.3% and import prices to dip -0.8%.

The actual result was a dip in export prices twice as big as economists expected and export prices half as much as economists expected. oops.

Moreover, the decline in export prices was outside the -0.4% to 0.0% range of any individual estimate.

Year-over-year export prices are down 6.3% and import prices down 9.4%.

With that, let's check out the Econoday Report.

Cross-border price pressures remain negative with import prices down 0.4 percent in November and export prices down 0.6 percent. Petroleum fell 2.5 percent in the month but is not an isolated factor pulling prices down as non-petroleum import prices fell 0.3 percent in the month. Agricultural exports are the wildcard on the export side and they fell a sizable 1.1 percent but here too, the deflationary pull is widespread with non-agricultural export prices down 0.6 percent.

Year-on-year contraction is perhaps less severe than prior months but not by much. Import prices are down a year-on-year 9.4 percent with non-petroleum import prices at minus 3.4 percent. Import prices from Canada are down the heaviest, at minus 18.0 percent on the year, with Latin America next at minus 12.7 percent. Showing the least price weakness are imports from China at minus 1.5 percent. Export prices are down 6.3 percent on the year with non-agricultural prices down 5.7 percent.

Of special concern are continuing incremental decreases for prices of finished goods, both imports and exports. Federal Reserve policy makers have been waiting for an easing drag from low import prices, not to mention oil prices as well, with neither yet to appear. Contraction in import prices not only reflects low commodity prices but also the strength of the dollar which has been giving U.S. buyers more for their dollars.

Since exports add to GDP and imports subtract, today's numbers, in isolation, suggest further weakening in GDP estimates.

Mike "Mish" Shedlock

Truck Rates Plunge; What About Actual Shipping Volumes? Strong Case for Pending Recession

Posted: 10 Dec 2015 12:01 AM PST

Trucking Spot Prices Plunge

Here's an interesting chart and commentary courtesy of James Jaillet who writes Truckload Rates Sunk Again in November.

Average per-mile rates on the spot market fell again for all three major truckload segments in November, according to data from loadboard Truckstop.com.

This is the fourth straight month that rates dipped in all three segments, continuing a now year-long downward trend spurred by both a major drop in diesel prices and market conditions.

Paid rates, verified averages of rates paid to carriers, fell 4 cents from October in reefer and flatbed segments and 7 cents in flatbed.

Paid reefer [refrigerated] rates in the month averaged $2.14, down 43 cents from last November. Rates in the segment have fallen 26 cents since May.

Fuel Costs

Let's dive into Freight Rate Index Data to see the reason for the plunge.

The index includes the following costs: Fuel, Wages, Equipment, Depreciation, Financing, Admin, Compliance, and Insurance. Nearly all of the volatility pertains to fuel and wages.

For August through November the downward trend is nearly all due to lower fuel costs. In the December 2 report a nearly 3 cent drop in fuel was nearly offset by a 3 cent rise in wages.

That tells us nothing about shipping volumes, the numbers I am really interested in. For shipments, let's look elsewhere starting with the Cass Freight Index.

Cass Freight Shipments Index

Cass nicely provides the data for both costs and shipments. Here is a subset of one of their tables.

Cass Freight Shipments
Month	2007	2008	2009	2010	2011	2012	2013	2014	2015
Jan	1.171	1.129	0.851	0.899	1.010	1.046	1.020	1.000	1.027
Feb	1.196	1.134	0.938	0.930	1.036	1.072	1.077	1.073	1.083
March	1.258	1.160	0.905	0.974	1.108	1.094	1.140	1.144	1.086
April	1.259	1.171	0.878	0.991	1.113	1.115	1.100	1.161	1.132
May	1.278	1.162	0.913	1.014	1.111	1.135	1.132	1.173	1.158
June	1.310	1.166	0.933	1.106	1.165	1.150	1.133	1.201	1.160
July	1.259	1.096	0.928	1.011	1.122	1.142	1.107	1.154	1.141
Aug	1.271	1.127	0.940	1.095	1.143	1.130	1.126	1.181	1.127
Sep	1.295	1.080	0.966	1.116	1.200	1.155	1.156	1.164	1.146
Oct	1.264	1.050	0.921	1.058	1.081	1.139	1.116	1.153	1.092
Nov	1.256	1.028	0.947	1.088	1.056	1.093	1.105	1.151
Dec	1.173	0.902	0.919	1.049	1.056	1.071	1.037	1.078

This was the worst October for shipments since 2011 and the worst September since 2010.

In addition, Every month this year except January and February were worse than the same month a year ago. That's eight consecutive months of declining shipments year-over-year.

Next let's take a look at a few highlights from the Cass Freight Report for October.

Cass Freight Index Report

Following the trend observed in the last four years, both total spend and the number of shipments for North American freight declined in October. The indexes have been below 2013 levels for the last several months. The first reading on third quarter GDP was a disappointing 1.5 percent annual growth rate, compared to 3.9 percent in the second quarter.

Consumer sector goods are, by far, the strongest in the market now. In many ways this is the silver lining in the storm clouds, because it means that consumers are still in the game. Consumer spending, which accounts for more than two‐thirds of U.S. economic activity, grew 3.2 percent in the third quarter after expanding at a 3.6 percent pace in the second quarter.

Shipment Volumes

The number of freight shipments dropped 4.7 percent from September. The freight shipments index now sits at its lowest October level since 2011. This month's decline was much sharper than in recent years and can be directly correlated to falling imports and exports as well as decreased domestic manufacturing levels. Burdened by bloated inventories, and under the shadow of a possible interest rate increase by the Federal Reserve, businesses cut back on new orders placed in the last three or four months. This is resulting in lower import volumes, less freight to move and faltering industrial production. With the dollar still strengthening, export growth decelerated in the third quarter. The Association of American Railroads reports that October traffic was down 4.3 percent from 2014 levels. More importantly, though, is that carloads dropped 20.7 percent and intermodal fell 20.3 percent from the previous month. Rail has been hit particularly hard by the rapid drop in industrial commodities caused by the steady decline in industrial production. Coal, petroleum and ores were down, while grain was up. The reductions in energy production are being felt throughout the freight community as shipments of not only petroleum, but also pipe, water, sand and other drilling materials, have dropped off significantly.

Overall Picture

Third quarter GDP growth was indicative of the economic headwinds facing the economy caused by the strong U.S. dollar (making U.S. goods less competitive abroad) and the weakening world economy. However, the consumer sector is rising to the occasion and continues to improve, providing the missing element to a full recovery from the Great Recession. Consumer spending has been bolstered by low inflation, especially with fuel prices; improving jobs creation; and stronger household purchasing power. In October, the Labor Department reported that 271,000 jobs were added and the unemployment rate dipped to 5 percent. A report from the Labor Department showed new applications for unemployment benefits last week hovering near levels last seen in late 1973. Growth in durable goods spending (for long‐lasting items such as washing machines and automobiles) continued strong, rising 6.7% in the third quarter. Inventory levels remain a looming problem as the Federal Reserve has been actively hinting that an interest rate hike is very possible in December. The combination of record inventory levels and an interest rate increase will cause a significant hike in inventory carrying costs. This will most likely drive a drawdown much like the one we saw in 2009 and 2010. Expect freight to continue to trail off through year's end. Retailers and wholesalers have ample supply for the holiday season, so imports and freight shipments should not strengthen considerably.

Mish Comments

All in all that was a balanced report by Cass. And providing the actual data to look at was a very nice touch.

Let's now discuss other points of view regarding GDP, inventories, and consumer spending.

Consumer Spending as Percent of GDP

It is widely believed that consumer spending accounts for approximately two-thirds of the economy. A few dispute that claim.

In Is the US Economy Close to a Bust, Pater Tenebrarum at the Acting Man Blog points out ...

One thing that we cannot stress often enough is that the manufacturing sector is far more important to the economy than its contribution to GDP would suggest. Since GDP fails to count all business spending on intermediate goods, it simply ignores the bulk of the economy's production structure. However, this is precisely the part of the economy where the most activity actually takes place. The reality becomes clear when looking at gross output per industry: consumer spending at most amounts to 35-40% of economic activity. Manufacturing is in fact the largest sector of the economy in terms of output.

To that I would add much of consumer spending is transfer payments: Food stamps, Medicare, Medicaid, etc. And health care costs have soared.

In The GDP Illusion Tenebrarum writes ...

Sure enough, in GDP accounting, consumption is the largest component. However, this is (luckily) far from the economic reality. Naturally, it is not possible to consume oneself to prosperity. The ability to consume more is the result of growing prosperity, not its cause. But this is the kind of deranged economic reasoning that is par for the course for today: let's put the cart before the horse!

Both articles are worth a closer look.

Inventory Levels

Cass cautioned "Inventory levels remain a looming problem as the Federal Reserve has been actively hinting that an interest rate hike is very possible in December. The combination of record inventory levels and an interest rate increase will cause a significant hike in inventory carrying costs."

That's an accurate synopsis but I suggest Cass understates the inventory problem.

Let's recap what I said Wednesday morning in Wholesale Trade: Another Bad Report, Inventories Decline, Prior Month Revised Way Lower; Expect Negative Revisions to 3rd and 4th Quarter GDP; What About Autos?

Inventories to Sales

Economists missed the wholesale trade report numbers by a mile. The Econoday Consensus Estimate for today's trade numbers was +0.2% in a range of 0.0% to 0.4%. The actual report (for October) came in at -0.1%.

That's bad enough, but some of the much touted inventory build for 3rd quarter (See Wholesale Trade Inventories Surge Led By Autos) did not happen.

Last month's report had me scratching my head. I certainly didn't expect such a jump. And it didn't happen. Today, September inventories were revised from +0.5% to +0.2%.

Positives for Production?

Bloomberg comments "[Wholesale trade inventories] may be negatives for third-quarter GDP but are positives for the production and employment outlooks."

Let's investigate that claim with a dive into the actual Census Report on Wholesale Trade for a chart and more details.

Inventories to Sales

The inventory-to-sales ratio is clearly in the danger zone. Over-optimism across the board is generally what causes these spikes.

Year-on-year, inventories are up 3.6 percent but sales are down 3.7 percent. Inventories contributed heavily to rather anemic GDP growth this year.

For more on perpetual overoptimism, please see Persistent Overoptimism Three Ways: Truckers, Fed Economists, Manufacturers

What About Autos?

Inquiring minds may be wondering about autos. So, let's take a look at autos and other categories.

Inventory and Sales - Percent Change From Year Ago
Group	Sales	Inventories	Sales-to-Inventory Ratio Current	Sales-to-Inventory Ratio Year Ago
US. Total	-3.7	3.6	1.31	1.22
Durable	-2.2	2.5	1.66	1.58
Automotive	2.3	13.1	1.77	1.6
Furniture	6.4	9.9	1.63	1.58

Autos are one of the key things that has been strong most of the year. Sales are up 2.3 percent but inventories are up 13.1%. And subprime lending has been a driving force behind those sales.

Across the board, inventories-to-sales seem way out of line.

Unless sales pick up dramatically (and I highly doubt they will), inventories will be a huge drag on growth that will not only negatively impact 3rd Quarter GDP estimates, but also GDP estimates for multiple quarters looking ahead.

Demographics

The demographic picture is not that pretty. I covered that recently in When Does the Demographically-Related Pension Ponzi Scheme Blow Up?

As a reader pointed out "Aging populations consume less, and have different consumption patterns to working populations. Retirees consume less food, autos and real estate compared to young working couples. They use more healthcare instead. Also, aging populations take on less debt. These factors combined make the economic effect of lowering interest rates and printing money less pronounced than they would be in different circumstances."

We're not talking about lower rates (until the Fed dramatically reverses course in 2016). Meanwhile, what prices are going up substantially more than others? And who is affected?

Apartment Rents
Medical

Rising medical expenses are part of consumer spending, but not a very productive one.

And soaring rent prices strongly affect those who cannot afford a house. Millennials are in that group.

Overseas, we have outright Population Deflation: Spain Joins Germany with Negative Net Birth Rate; Italy on Threshold; Who's to Blame?

The US is much better off than Europe and Japan, but what does that say for US export prospects?

Jobs

Cass noted "A report from the Labor Department showed new applications for unemployment benefits last week hovering near levels last seen in late 1973."

That's accurate.

But what does that mean looking ahead? That things are going to get even better? If so, how much better?

Initial Claims

Strong Case for Recession

Jobs are the laggiest of laggy indicators. A turn down here would not be welcome at all.

But why shouldn't jobs turn down precisely here?

Inventories are up
Sales are down
The Fed is hiking
Corporate profits stalled
The recovery is above average in duration
Manufacturing is in outright recession
New home sales are weak at best
Existing home sales are down and a NAR Report Calls the Report "Disturbing"
Trucking is down
The energy sector is a bust
Auto sales are hugely subprime
Big box retailers struggling
Mall vacancies increasing
Consumer Spending Much Weaker Than Expected last two months

What's next? No hiring? Outright layoffs?

I believe there's a pretty decent chance the US is about to slip into recession, if it hasn't done so already.

Mike "Mish" Shedlock

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