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The Problem with the Phillips Curve

Saturday, August 16th, 2014

7046305715_824084ddf1_o I remember sitting in my intermediate macroeconomics class at Johns Hopkins, when the Professor was trying to develop the concept of the Phillips Curve, which posits a trade-off between labor unemployment and price inflation, at least in the short run.  The time was the Fall of 1980, and macroeconomics was trying to catch up with what happened with stagflation, because that was not something that expected would come from their policy recommendations that offered the politicians a free lunch.

This trade-off underlies the concept of the dual mandate of the Federal Reserve, where they are not only to try to restrain price inflation, but also aim for full labor employment.  I don’t think it is realistic to do this for two reasons.

1) For the theory of the Phillips Curve to work, the central assumption is that price inflation funnels directly into wage inflation.  This is a questionable assumption, as I will explain below.

2) The FOMC has a hard enough time using monetary policy to restrain or accelerate price inflation.

Why might price inflation vary from wage inflation?  There are two main reasons in the present: technological improvements that require less labor to produce the same or better output, and an increase in overseas laborers available to produce good or services outside the US for sale inside the US.  Notice I am not mentioning immigration, though that might have a small impact on the wages of the lowest-skilled jobs in the short run.

I see both of these factors acting at present, which until our economy adjusts to create more jobs, initially at lower pay than most will want, will restrain the growth in wages, particularly adjusted for inflation.

  1. Now, give Janet Yellen some credit, because she recognizes the weakness of looking at the headline unemployment number as a guide to policy and has broadened out her labor market indicators to reflect that a low U-3 unemployment rate doesn’t mean the labor market is great.  She looks at the rates of layoffs/firings, job openings, voluntary quitting, hiring, and labor force partipation, among others.
  2. This is similar to what I suggested in a recent post on labor underemployment.  Payments to labor are a smaller fraction of the economy, and real wages have flatlined.
  3. That said, I don’t think the Fed can succeed here, because the relationship between monetary policy and real wages is nonexistent as far as I can see.  The Fed is better at inflating assets in an era where the better-off save, than it is in inflating prices, which it more direct effect on than wages.
  4. There is slow but steady pressure for wage rates to equalize globally, slowly but surely.  Being born in the West is not in itself a ticket to above average wages.

I don’t blame the Fed for the poor labor market conditions; it’s not in their power.  Maybe we can blame Congress and the Executive Branch for making laws that inhibit hiring and firing, both at the national and state levels.  We might blame the schools for not taking a more balanced approach to education, stressing vocational education alongside a strong liberal arts education that includes real science and math.  Parents, if the school systems don’t do this, if your children will listen to you, get them thinking along these lines.

You are your own best defender with respect to your own employment, so put some thought into alternative work, should you find yourself unemployed.  Analyze how you can meet the most needs/demands of others and fill those needs/demands, and you will never lack work.

I wish you the best in a tough labor market.

The Shadows of the Bond Market’s Past, Part II

Wednesday, August 13th, 2014

This is the continuation of The Shadows of the Bond Market’s Past, Part I.  If you haven’t read part I, you will need to read it.  Before I start, there is one more thing I want to add regarding 1994-5: the FOMC used signals from the bond markets to give themselves estimates of expected inflation.  Because of that, the FOMC overdid policy, because the dominant seller of Treasuries was not focusing on the economy, but on hedging mortgage bonds.  Had the FOMC paid more attention to what the real economy was doing, they would not have tightened so much or so fast.  Financial markets are only weakly representative of what the real economy is doing; there’s too much noise.

All that said, in 1991 the Fed also overshot policy on the other side in order to let bank balance sheets heal, so let it not be said that the Fed only responds to signals in the real economy.  (No one should wonder who went through the financial crisis that the Fed has an expansive view of its mandate in practice.)

October 2001

2001 changed America.  September 11th led to a greater loosening of credit by the FOMC in order to counteract spreading unease in the credit markets.  Credit spreads were widening quickly as many lenders were unwilling to take risk at a time where times were so unsettled.  The group that I led took more risk, and the story is told here.  The stock market had been falling most of 2001 when 9/11 came.  When the markets reopened, it fell hard, and rallied into early 2002, before falling harder amid all of the scandals and weak economy, finally bottoming in October 2002.

The rapid move down in the Fed funds rate was not accompanied by a move down in long bond yields, creating a very steep curve.  There were conversations among analysts that the banks were healthy, though many industrial firms, like automobiles were not.  Perhaps the Fed was trying to use housing to pull the economy out of the ditch.  Industries that were already over-levered could not absorb more credit from the Fed.  Unemployment was rising, and inflation was falling.

There was no bad result to this time of loosening — another surprise would lurk until mid-2004, when finally the loosening would go away.  By that time, the stock market would be much higher, about as high as it was in October 2001, and credit spreads tighter.

July 2004

At the end of June 2004, the FOMC did its first hike of what would be 17 1/4% rises in the Fed funds rate which would be monotony interspersed with hyper-interpretation of FOMC statement language adjustments, mixed with the wonder of a little kid in the back seat, saying, “Daddy, when will we get there?”  The FOMC had good reason to act.  Inflation was rising, unemployment was falling, and they had just left the policy rate down at 1% for 12 straight months.  In the midst of that in June-August 2003, there was a another small panic in the mortgage bond market, but this time, the FOMC stuck to its guns and did not raise rates, as they did for something larger in 1994.

With the rise in the Fed funds rate to 1 1/4%, the rate was as high as it was when the recession bottomed in November 2002.  That’s quite a long period of low rates.  During that period, the stock market rallied vigorously, credit spreads tightened, and housing prices rallied.  Long bonds stayed largely flat across the whole period, but still volatile.

There were several surprises in store for the FOMC and investors as  the tightening cycle went on:

  1. The stock market continued to rally.
  2. So did housing.
  3. So did long bonds, at least for a time.
  4. Every now and then there were little panics, like the credit convexity panic in May 2005, from a funky long-short CDO bet.
  5. Credit complexity multiplied.  All manner of arbitrage schemes flourished.  Novel structures for making money off of credit, like CPDOs emerge.  (The wisdom of finance bloggers as skeptics grows.)
  6. By the end, the yield curve invests the hard way, with long bonds falling a touch through the cycle.
  7. Private leverage continued to build, and aggressively, particularly in financials.
  8. Lending standards deteriorated.

We know how this one ended, but at the end of the tightening cycle, it seemed like another success.  Only a few nut jobs were dissatisfied, thinking that the banks and homeowners were over-levered.  In hindsight, FOMC policy should have moved faster and stopped at a lower level, maybe then we would have had less leverage to work through.

June 2010

15 months after the bottom of the crisis, the stock market has rallied dramatically, with a recent small fall, but housing continues to fall in value.  There’s more leverage behind houses, so when the prices do finally fall, it gains momentum as people throw in the towel, knowing they have lost it all, and in some cases, more.  For the past year, long bond yields have gone up and down, making a round-trip, but a lot higher than during late 2008.  Credit spreads are still high, but not as high as during late 2008.

Inflation is low and volatile, unemployment is off the peak of a few months earlier, but is still high.  Real GDP is growing at a decent clip, but fitfully, and it is still not up to pre-crisis levels.  Aside from the PPACA [Obamacare], congress hasn’t done much of anything, and the Fed tries to fill the void by expanding its balance sheet through QE1, which ended in June 2010. Things feel pretty punk altogether.

The FOMC can’t cut the Fed funds rate anymore, so it relies on language in its FOMC Statement to tell economic actors that Fed funds will be “exceptionally low” for an “extended period.”  Four months from then, the QE2 would sail, making the balance sheet of the Fed bigger, but probably doing little good for the economy.

The results of this period aren’t fully known yet because we still living in the same essential macro environment, with a few exceptions, which I will take up in the final section.

August 2014

Inflation remains low, but may finally be rising.  Unemployment has fallen, much of it due to discouraged workers, but there is much underemployment.  Housing has finally gotten traction in the last two years, but there are many cross-currents.  The financial crisis eliminated move-up buyers by destroying their equity.  Stocks have continued on a tear, and corporate credit spreads are very tight, tighter than any of the other periods where the yield curve was shaped as it is now.  The long bond has had a few scares, but has confounded market participants by hanging around in a range of 2.5%- 4.0% over the last two years.

There are rumblings from the FOMC that the Fed funds rate may rise sometime in 2015, after 72+ months hanging out at 0%.  QE may end in a few more months, leaving the balance sheet of the Fed at 5 times its pre-crisis size.  Change may be upon us.

This yield curve shape tends to happen over my survey period at a time when change is about to happen (4 of 7 times — 1971, 1977, 1993 and 2004), and one where the FOMC will raise rates aggressively (3 of 7 times — 1977, 1993 and 2004) after fed funds have been left too low for too long.  2 out of 7 times, this yield curve shape appears near the end of a loosening cycle (1991 and 2001).  1 out of 7 times it appears before a deep recession, as in 1971. 1 out of 7 times it appears in the midst of an uncertain recovery — 2010. 3 out 7 times, inflation will rise significantly, such as in 1971, 1977 and 2004.

My tentative conclusion is this… the fed funds rate has been too low for too long, and we will see a rapid rise in rates, unless the weak economy chokes it off because it can’t tolerate any significant rate increases.  One final note before I close: when the tightening starts, watch the long end of the yield curve.  I did this 2004-7, and it helped me understand what would happen better than most observers.  If the yield of the long bond moves down, or even stays even, the FOMC probably won’t persist in raising rates much, as the economy is too weak.  If the long bond runs higher, it might be a doozy of a tightening cycle.

And , for those that speculate, look for places that can’t tolerate or would  love higher short rates.  Same for moves in the long bond either way, or wider credit spreads — they can’t get that much tighter.

This is an unusual environment, and as I like to say, “Unusual typically begets unusual, it does not beget normal.”  What I don’t know is how unusual and where.  Those getting those answers right will do better than most.  But if you can’t figure it out, don’t take much risk.

The Shadows of the Bond Market’s Past, Part I

Tuesday, August 12th, 2014

Simulated Constant Maturity Treasury Yields 8-1-14_24541_image001

 

Source: FRED

Above is the chart, and here is the data for tonight’s piece:

DateT1T3T5T7T10T20T30AAABAASpdNote
3/1/713.694.505.005.425.705.946.01*7.218.461.25High
4/1/775.446.316.797.117.377.677.738.049.071.03Med
12/1/914.385.396.196.697.097.667.708.319.260.95Med
8/1/933.444.365.035.355.686.276.326.857.600.75Med
10/1/012.333.143.914.314.575.345.327.037.910.88Med
7/1/042.103.053.694.114.505.245.235.826.620.80Med
6/1/100.321.172.002.663.203.954.134.886.231.35High
8/1/140.130.941.672.162.523.033.294.184.750.57Low

Source: FRED   |||     * = Simulated data value  |||  Note: T1 means the yield on a one-year Treasury Note, T30, 30-year Treasury Bond, etc.

Above you see the seven yield curves most like the current yield curve, since 1953.  The table also shows yields for Aaa and Baa bonds (25-30 years in length), and the spread between them.

Tonight’s exercise is to describe the historical environments for these time periods, throw in some color from other markets, describe what happened afterward, and see if there might be any lessons for us today.  Let’s go!

March 1971

Fed funds hits a local low point as the FOMC loosens policy under Burns to boost the economy, to fight rising unemployment, so that Richard Nixon could be reassured re-election.  The S&P 500 was near an all-time high.  Corporate yield spreads  were high; maybe the corporate bond market was skeptical.

1971 was a tough year, with the Vietnam War being unpopular. Inflation was rising, Nixon severed the final link that the US Dollar had to Gold, an Imposed wage and price controls.  There were two moon landings in 1971 — the US Government was in some ways trying to do too much with too little.

Monetary policy remained loose for most of 1972, tightening late in the years, with the result coming in 1973-4: a severe recession accompanied by high inflation, and a severe bear market.  I remember the economic news of that era, even though I was a teenager watching Louis Rukeyser on Friday nights with my Mom.

April 1977

Once again, Fed funds is very near its local low point for that cycle, and inflation is rising.  After the 1975-6 recovery, the stock market is muddling along.  The post-election period is the only period of time in the Carter presidency where the economy feels decent.  The corporate bond market is getting close to finishing its spread narrowing after the 1973-4 recession.

The “energy crisis” and the Cold War were in full swing in April 1977.  Economically, there was no malaise at the time, but in 3 short years, the Fed funds rate would rise from 4.73% to 17.61% in April 1980, as Paul Volcker slammed on the brakes in an effort to contain rising inflation.  A lotta things weren’t secured and flew through the metaphorical windshield, including the bond market, real GDP, unemployment, and Carter’s re-election chances.  Oddly, the stock market did not fall but muddled, with a lot of short-term volatility.

December 1991

This yield curve is the second most like today’s yield curve.  It comes very near the end of the loosening that the FOMC was doing in order to rescue the banks from all of the bad commercial real estate lending they had done in the late 1980s.  A wide yield curve would give surviving banks the ability to make profits and heal themselves (sound familiar?).  Supposedly at the beginning of that process in late 1990, Alan Greenspan said something to the effect of “We’re going to give the banks a lay-up!”  Thus Fed funds went from 7.3% to 4.4% in the 12 months prior to December 1991, before settling out at 3% 12 months later.  Inflation and unemployment were relatively flat.

1991 was a triumphant year in the US, with the Soviet Union falling, Gulf War I ending in a victory (though with an uncertain future), 30-year bond yields hitting new lows, and the stock market hitting new all time highs.  Corporate bonds were doing well also, with tightening spreads.

What would the future bring?  The next section will tell you.

August 1993

This yield curve is the most like today’s yield curve.  Fed funds are in the 13th month out of 19 where they have been held there amid a strengthening economy.  The housing market is doing well, and mortgage refinancing has been high for the last three years, creating a situation where those investing in mortgages securities have a limited set of coupon rates that they can buy if they want to put money to work in size.

An aside before I go on — 1989 through 1993 was the era of clever mortgage bond managers, as CMOs sliced and diced bundles of mortgage payments so that managers could make exotic bets on moves in interest and prepayment rates.  Prior to 1994, it seemed the more risk you took, the better returns were.  The models that most used were crude, but they thought they had sophisticated models.  The 1990s were an era where prepayment occurred at lower and lower thresholds of interest rate savings.

As short rates stayed low, long bonds rallied for two reasons: mortgage bond managers would hedge their portfolios by buying Treasuries as prepayments occurred.  They did that to try to maintain a constant degree of interest rate sensitivity to overall moves in interest rates.  Second, when you hold down short rates long enough, and you give the impression that they will stay there (extended period language was used — though no FOMC Statements were made prior to 1994), bond managers start to speculate by buying longer securities in an effort to clip extra income.  (This is the era that this story (number 2 in this article) took place in, which is part of how the era affected me.)

At the time, nothing felt too unusual.  The economy was growing, inflation was tame, unemployment was flat.  But six months later came the comeuppance in the bond market, which had some knock-on effects to the economy, but primarily was just a bond market issue.   The FOMC hiked the Fed funds rate in February 1994 by one quarter percent, together with a novel statement issued by Chairman Greenspan.  The bond market was caught by surprise, and as rates rose, prepayments fell.  To maintain a neutral market posture, mortgage bond managers sold long Treasury and mortgage bonds, forcing long rates still higher.  In the midst of this the FOMC began raising the fed funds rate higher and higher as they feared economic growth would lead to inflation, with rising long rates a possible sign of higher expected inflation.  The FOMC raises Fed fund by 1/2%.

In April, thinking they see continued rises in inflation expectation, they do an inter-meeting surprise 1/4% raise of Fed funds, followed by another 1/2% in May.  It is at this pint that Vice Chairman McDonough tentatively realizes [page 27] that the mortgage market has now tightly coupled the response of the long end of the bond market to the short end the bond market, and thus, Fed policy.  This was never mentioned again in the FOMC Transcripts, though it was the dominant factor moving the bond markets.  The Fed was so focused on the real economy, that they did not realize their actions were mostly affecting the financial economy.

FOMC policy continued: Nothing in July, 1/2% rise in August, nothing in September, 3/4% rise in November, nothing in December, and 1/2% rise in February 1995, ending the tightening. In late December 1994 and January of 1995, the US Treasury and the Fed participated in a rescue of the Mexican peso, which was mostly caused by bad Mexican economic policy, but higher rates in the US diminished demand for the cetes, short-term US Dollar-denominated Mexican government notes.

The stock market muddled during this period, and the real economy kept growing, inflation in check, and unemployment unaffected.  Corporate spreads tightened; I remember that it was difficult to get good yields for my Guaranteed Investment Contract [GIC] business back then.

But the bond markets left their own impacts: many seemingly clever mortgage bond managers blew up, as did the finances of Orange County, whose Treasurer was a mortgage bond speculator.  Certain interest rate derivatives blew up, such as the ones at Procter & Gamble.  Several life insurers lost a bundle in the floating rate GIC market; the company I served was not one of them.  We even made extra money that year.

The main point of August 1993 is this: holding short rates low for an extended period builds up imbalances in some part of the financial sector — in this case, it was residential mortgages.  There are costs to providing too much liquidity, but the FOMC is not an institution with foresight, and I don’t think they learn, either.

This has already gotten too long, so I will close up here, and do part II tomorrow.  Thanks for reading.

A Few Investment Notes

Saturday, August 9th, 2014

Just a few notes for this evening:

1) I’ve been a bull on the long end of the Treasury curve for a while.  It’s been a winning bet, and the drumbeat of “interest rates have nowhere to go but up” continues.  Here’s an argument from Jeffrey Gundlach on why long rates should remain low, and maybe go lower:

Gundlach, however, was one of the very few people who believed rates would stay low, especially with the Federal Reserve committed to keeping rates low with its loose monetary policy.

It’s important to note that U.S. Treasuries don’t have the lowest yields in the world. French and German government bonds have yields that are about 100 basis points lower than those of Treasuries. In other words, those European bonds actually make U.S. bonds look cheap, meaning that yields have room to go lower.

This will trend toward lower rates will eventually have to end, but neither GDP growth, inflation, or business lending justifies it at present.

2) From Josh Brown, he notes that correlations went up considerably with all risk assets in the last bitty panic.  Worth a read.  My two cents on the matter comes from my recent article, On the Recent Anxiety in High Yield Bonds, where I noted how much yieldy stocks got hit — much more than expected.  I suspect that some asset allocators with short-dated or small stop-loss trading rules began selling into the bitty panic, but that is just a guess.

3) That would help to explain the loss of liquidity in the bond market during the bitty panic.  This article from Tracy Alloway at the FT explores that topic.  One commenter asked:

Isn’t it a bit odd to say lots of people sold quickly *and* that there isn’t enough liquidity? 

Liquidity means a number of things.  In this situation, spreads widened enough that parties that wanted to sell had to give up price to do so, allowing the brokers more room to sell them to skittish buyers willing to commit funds.  Sellers were able to get trades done at unfavorable levels, but they were determined to get the trades done, and so they were done, and a lot of them.  Buyers probably had some spread target that they could easily achieve during the bitty panic, and so were willing to take on the bonds.  Having a balance sheet with slack is a great thing when others need liquidity now.

One other thing to note from the article is that it mentioned that retail investors now own 37% of credit, versus 29% in 2007, according to RBS. Also that investment funds has been able to buy all of the new corporate debt sold since 2008.

There’s more good stuff in the article including how “matrix pricing” may have influenced the selloff.  When spreads were so tight, it may not have taken a very large initial sale to make the estimated prices of other bonds trade down, particularly if the sales were of lower-rated, less-traded bonds.  Again, worth a read.

4) Regarding credit scores, three articles:

From the WSJ article:

Fair Isaac Corp. said Thursday that it will stop including in its FICO credit-score calculations any record of a consumer failing to pay a bill if the bill has been paid or settled with a collection agency. The San Jose, Calif., company also will give less weight to unpaid medical bills that are with a collection agency.

I think there is less here than meets the eye.  This only affects those borrowing from lenders using the particular FICO scores that were modified.  Not all lenders use that particular score, and many use FICO data disaggregated to create their own score, or ask FICO to give them a custom score that they use.  Again, from the WSJ article:

Fair Isaac releases new scoring models every few years, and it is up to lenders to choose which ones to use. The new score will likely be adopted by credit-card and auto lenders first, says John Ulzheimer, president of consumer education at CreditSesame.com and a former Fair Isaac manager.

Mortgages are likely to lag, since the FICO scores used by most mortgage lenders are two versions old.

The impact of the changes on borrowers is likely to be significant. Accounts that are sent to collections, including credit-card debts and utility bills, can stay on borrowers’ credit reports for as long as seven years, even when their balance drops to zero, and can lower their scores by up to 100 points, said Mr. Ulzheimer.

The lower weight given to unpaid medical debt could increase some affected borrowers’ FICO scores by 25 points, said Mr. Sprauve.

But lowering the FICO score by itself doesn’t do anything.  Some lenders don’t adjust their hurdles to reflect the scores, if they think the score is a better measure of credit for their time-horizon, and they want more loan volume.  Others adjust their hurdles up, because they want only a certain volume of loans to be made, and they want better quality loans at existing pricing.

Megan McArdle at Bloomberg View asks a different question as to whether it is good to extend more credit to marginal borrowers?  Didn’t things go wrong doing that before?  Her conclusion:

That in itself [DM: pushing for more loans to marginal borrowers as a matter of policy] is an interesting development. Ten years ago, politicians were pressing hard for banks to extend the precious boon of homeownership to every man, woman and shell corporation in America. Five years ago, when people were pushing for something like the CFPB, the focus of the public debate had dramatically shifted toward protecting people from credit. Oh, there were complaints about the cost of subprime loans, but ultimately, on most of those loans, the problem wasn’t the interest rate but the principal: Too many people had taken out loans that they could not realistically afford to pay, especially if anything at all went wrong in their lives, from a job loss to a divorce to an unexpected illness. And so you heard a lot of complaints about predatory lenders who gave people more credit than they could handle.

Credit has tightened considerably since then, and now, it appears, we’re unhappy with that. We want cheaper, easier credit for everyone, and particularly for the kind of financially struggling people who have seen their credit scores pummeled over the last decade. And so we see the CFPB pressing FICO to go easier on people with satisfied collections.

That’s not to say that the CFPB is wrong; I don’t know what the ideal amount of credit is in a society, or whether we are undershooting the mark. What I do think is that the U.S. political system — and, for that matter, the U.S. financial system — seems to have a pretty heavy bias toward credit expansion. Which explains a lot about the last 10 years.

Personally, I look at this, and I think we don’t learn.  Credit pulls demand into the present, which is fine if it doesn’t push losses and heartache into the future.  We are better off with a slower, less indebted economy for a time, and in the end, the economy as a whole will be better off, with people saving to buy in the future, rather than running the risk of defaults, and a very punk economy while we work through the financial losses.

Regarding Underemployment

Saturday, August 2nd, 2014

This is just meant to be a few thoughts.  I haven’t worked everything out, but I want to talk about how the labor markets are weak.

Yes, the headline statistics are strong.  The U-3 unemployment figure is low at 6.2%.  But look at a few other statistics:

My, but wages as a share of GDP has been falling.

And real wages have flatlined.  No surprise that many feel pinched in the present environment.  Even the Federal Reserve Chairwoman Janet Yellen expresses her doubts about the labor markets, which was expressed through the most recent FOMC Statement.

The problem is this: the relationship between labor employment and monetary policy is weak.  It is weaker than pushing on a string.  There are two major factors retarding the US labor market, and they are globalization and increased productivity from technology.

The value of knowledge is rising relative to less-skilled labor.  As such, we are seeing increased income inequality in the US, but lower income inequality globally.  Bright people in foreign lands who can transmit their skills over the internet can do better for themselves, even as more expensive counterparts in the US lose business.

Call this the revenge of the nerds.  The internet enables bright people to profit from their differential knowledge, as it can be applied to wider opportunities.

Think of India for a moment.  Many bright people with advanced degrees, but education amounts to little unless you can use it for your own benefit.

Here’s my main point.  The FOMC con’t do much about the labor markets; their power is weak.  The bigger factors of globalization and technology can’t be fought.  They are too big.

Thus, you are on your own.  The US Government does not have the power to re-create the unique middle class prosperity of the ’50s and ’60s.  If you work for others, you are not your own master.  Aim to make yourself the master of your situation, by making yourself invaluable to your clients.

Not Apt, Not Teed Up, Not Going

Saturday, August 2nd, 2014

Okay, let’s run the promoted stocks scoreboard:

TickerDate of ArticlePrice @ ArticlePrice @ 6/27/14DeclineAnnualizedSplits
GTXO5/27/20082.450.022-99.1%-53.3% 
BONZ10/22/20090.350.001-99.8%-72.8% 
BONU10/22/20090.890.000-100.0%-85.1% 
UTOG3/30/20111.550.000-100.0%-92.3% 
OBJE4/29/2011116.000.069-99.9%-89.7%1:40
LSTG10/5/20111.120.010-99.1%-81.2% 
AERN10/5/20110.07700.0001-99.9%-90.5% 
IRYS3/15/20120.2610.000-100.0%-100.0%Dead
RCGP3/22/20121.470.045-96.9%-77.2% 
STVF3/28/20123.240.340-89.5%-61.8% 
CRCL5/1/20122.220.008-99.6%-91.7% 
ORYN5/30/20120.930.026-97.2%-80.7% 
BRFH5/30/20121.160.779-32.8%-16.8% 
LUXR6/12/20121.590.006-99.7%-93.0% 
IMSC7/9/20121.51.220-18.7%-9.5% 
DIDG7/18/20120.650.042-93.6%-74.0% 
GRPH11/30/20120.87150.073-91.6%-77.4% 
IMNG12/4/20120.760.015-98.0%-90.6% 
ECAU1/24/20131.420.004-99.7%-97.8% 
DPHS6/3/20130.590.007-98.9%-97.9% 
POLR6/10/20135.750.050-99.1%-98.4% 
NORX6/11/20130.910.090-90.1%-86.9% 
ARTH7/11/20131.240.200-83.9%-82.2% 
NAMG7/25/20130.850.085-90.0%-89.6% 
MDDD12/9/20130.790.060-92.4%-98.2% 
TGRO12/30/20131.20.150-87.5%-97.1% 
VEND2/4/20144.341.500-65.4%-88.7% 
HTPG3/18/20140.720.100-86.1%-99.5% 
WSTI6/27/20141.350.735-45.6%-99.8% 
 8/1/2014 Median-97.2%-89.6%

 

Now for tonight’s loser-in-waiting: Apptigo [APPG].  This is a company that  until four months ago was a development stage company for selling Irish horses in the US.  This is a company that has never earned any money, and only has positive net worth at present because of raising capital when the prior company acquired Apptigo in a reverse marger, and renamed itself Apptigo.

This is a company that says it will make money off of selling apps.  Well, they have one app at present, and it is called SCORE – Match Maker.  It has a grand total of seven likes at the iTunes Store.  Now let me hazard a guess here, and say that it is difficult to create a broad network for matchmaking.  The value of a network goes up proportional to the square of its nodes.  How will they attract enough attention in the iTunes ecosystem to make  a significant network?  Even if this is a legitimate company, I don’t see how it will be easy to make it work, as the promoter said it would be easy.

The promoter also said this in tiny type:

Important Notice and Disclaimer: Flying Under the Radar Stocks is an independent paid circulation newsletter. This report is a solicitation for subscriptions and a paid promotional advertisement of Apptigo, Inc. (APPG). Flying Under the Radar Stocks received an editorial fee of twenty five thousand dollars from Micro Cap Media Ltd. APPG was chosen to be profiled after Flying Under the Radar Stocks completed due diligence on APPG. Flying Under the Radar Stocks expects to generate new subscriber revenue the amount of which is unknown at this time resulting from the distribution of this report. Micro Cap Media Ltd. paid nine hundred forty-eight thousand, three hundred sixty-three dollars to advertising agencies for the cost of creating and distributing this report, including printing and postage, in an effort to build investor awareness. This report does not provide an analysis of a company’s financial position, operations or prospects and this is not to be construed as a recommendation by Micro Cap Media Ltd. or an offer to buy or sell any security or investment advice. An offer to buy or sell can only be made with accompanying disclosure documents and only in states and provinces for which they are approved. Do not base any investment decision based solely on information in this report. Although the information contained in this advertisement is believed to be reliable, Micro Cap Media Ltd. makes no warranties as to the accuracy of any of the contents herein and accepts no liability for how readers may choose to utilize the content. Readers should perform their own due diligence, including consulting with a licensed, qualified investment professional. Further, readers are strongly urged to independently verify all statements made in this report APPG’s financial position and all other information regarding APPG should be verified directly with APPG Audited financial statements and other relevant information about APPG can be found at the Security and Exchange Commission’s website at www.sec.gov. It is recommended that any investment in any security should be made only after consulting with your investment advisor and only after reviewing all publicly available information, including the financial statements of the company. The information contained herein contains forward-looking information within the meaning of section 27a of the Securities Act of 1933 as amended and section 21e of the Securities Act of 1934 as amended including statements regarding growth of APPG. In accordance with the safe harbor provisions of the Private Securities Litigation Reform Act, statements contained herein that look forward in time, which include everything other than historical information, involve risks and uncertainties.  All forward-looking statements are based upon current assumptions that are believed to be reasonable. In the event any such assumptions turn out to be incorrect, forward-looking statements based upon those assumptions will not be accurate. Flying Under the Radar Stocks presents information in this report believed to be reliable, but its accuracy cannot be guaranteed. More information can be found at APPG’s website www.apptigo.com. (underline emphasis mine)

I actually like this disclaimer, except for the fact that it is in tiny type, while the proclamation of the investment’s fake virtues are in big type.  So, I have a simple proposal for the SEC regarding newsletters like this: the type size of any disclaimer must be as large as the the largest type in the document.

This is fair, and consistent with other laws that regulate “the fine print.”

I emailed the CEO of Apptigo to ask him whether he knew about the stock promotions (there are three going on), and whether the company, its major shareholders, or its management was benefiting from the promotion.  There was no answer, though I wrote to him on Thursday.

Regardless, avoid promoted stocks, dear friends.  No company of any good reputation pays anyone to promote their stock.  Avoid promoted stocks.

Social Security Troubles

Thursday, July 31st, 2014

We have known for many years that Social Security’s Disability Trust Fund was in far worse  shape than the Retirement Trust Fund, which is also not in good shape.  The rolls for Social Security Disability have risen dramatically since 2009, with many applying for disability amid a time where jobs are hard to find.  Personally, I think that people should plan for their own possible disability, and it not be something that the government covers.

That said, the disability trust fund will run out of money in 2016.  The most likely result in my opinion, is that  the disability trust fund will borrow from the the retirement trust fund, accelerating the insolvency of the retirement trust fund, currently scheduled to make a change to payments in 2026, when it has only one year of payments left in the trust fund, and will have to pro-rate all payments, so that the payments will be made from existing tax payments plus assets on hand.  This means that social security retirement and disability payments will be cut by around 27%.

The politics of this is complicated, and I don’t pretend to have an absolute answer to how this will all work out.  My past dealings with these issues indicate that if the problem can be deferred, it will be deferred.   Borrowing from the retirement trust fund ruffles few feathers, and allows politicians 10 years or so of breathing room, after whichthey may have resigned or retired.

At some point in the future the following phrase will be common: “You got what you deserved, because you trusted the government.”  Add in the troubles at Medicare, where the trust fund also will run out before 2020.

If you are relying on Social Security, you are in a bad spot,  Either taxes will be raised, or benefits will be cut, either across-the-board, or selectively.

This will be a fight, as most other things in our government budget are, and there is no telling how it will turn out.  There is only one certain thing: if we had dealt with this 25-35 years ago, we would not be in this pickle now.  Shame on our parents’ generation, and shame on us, if you are over age 35.  More guilt to those who are older.

Redacted Version of the July 2014 FOMC Statement

Wednesday, July 30th, 2014
June 2014July 2014Comments
Information received since the Federal Open Market Committee met in April indicates that growth in economic activity has rebounded in recent months.Information received since the Federal Open Market Committee met in June indicates that growth in economic activity rebounded in the second quarter.This is another overestimate by the FOMC.
Labor market indicators generally showed further improvement. The unemployment rate, though lower, remains elevated.Labor market conditions improved, with the unemployment rate declining further. However, a range of labor market indicators suggests that there remains significant underutilization of labor resources. More people working some amount of time, but many discouraged workers, part-time workers, lower paid positions, etc.
Household spending appears to be rising moderately and business fixed investment resumed its advance, while the recovery in the housing sector remained slow.Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow.No real change

 

Fiscal policy is restraining economic growth, although the extent of restraint is diminishing.Fiscal policy is restraining economic growth, although the extent of restraint is diminishing.No change.  Funny that they don’t call their tapering a “restraint.”
Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.Inflation has moved somewhat closer to the Committee’s longer-run objective. Longer-term inflation expectations have remained stable.Finally notes that inflation has risen.  TIPS are showing slightly higher inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.60%, up 0.14% from June.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.No change. Any time they mention the “statutory mandate,” it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate.The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate.Adds in inflation, also changes measure of the labor market to broaden it from “conditions” to “indicators,” not that that will help much.

They can’t truly affect the labor markets in any effective way.

The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat.CPI is at 2.1% now, yoy.  They shade up their view on inflation’s amount and persistence.
The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.No change.
In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in July, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $15 billion per month rather than $20 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $20 billion per month rather than $25 billion per month.In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in August, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $10 billion per month rather than $15 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $15 billion per month rather than $20 billion per month.Reduces the purchase rate by $5 billion each on Treasuries and MBS.  No big deal.

 

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.No change
The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.No change.  But it has almost no impact on interest rates on the long end, which are rallying into a weakening global economy.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.No change. Useless paragraph.
If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetingsNo change.  Says that purchases will likely continue to decline if the economy continues to improve.
However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.No change.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate.To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate.No change.
In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.No change.  Monetary policy is like jazz; we make it up as we go.  Also note that progress can be expected progress – presumably that means looking at the change in forward expectations for inflation, etc.
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.No change.  Its standards for raising Fed funds are arbitrary.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.No change.
The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.No change.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Richard W. Fisher; Narayana Kocherlakota; Loretta J. Mester; Charles I. Plosser; Jerome H. Powell; and Daniel K. Tarullo.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Richard W. Fisher; Narayana Kocherlakota; Loretta J. Mester; Jerome H. Powell; and Daniel K. Tarullo.Plosser dissents.  Finally someone with a little courage.
 Voting against was Charles I. Plosser who objected to the guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for “a considerable time after the asset purchase program ends,” because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee’s goals.Thank you, Mr. Plosser.  The end to easing is coming, but what will happen when it starts to bite?

 

Comments

  • The two main points of this FOMC statement are: 1)  The Fed recognizes that inflation has risen, and is likely to persist. 2)   Despite lower unemployment levels, labor market conditions are still pretty punk.  Much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.  Wage growth is weak also.
  • Markets don’t move much on the news.  Really, not a lot here.
  • Small $10 B/month taper.  Equities and long bonds both rise.  Commodity prices rise.  The FOMC says that any future change to policy is contingent on almost everything.
  • Don’t know they keep an optimistic view of GDP growth, especially amid falling monetary velocity.
  • The FOMC needs to chop the “dead wood” out of its statement.  Brief communication is clear communication.  If a sentence doesn’t change often, remove it.
  • In the past I have said, “When [holding down longer-term rates on the highest-quality debt] doesn’t work, what will they do?  I have to imagine that they are wondering whether QE works at all, given the recent rise and fall in long rates.  The Fed is playing with forces bigger than themselves, and it isn’t dawning on them yet.
  • The key variables on Fed Policy are capacity utilization, labor market indicators, inflation trends, and inflation expectations.  As a result, the FOMC ain’t moving rates up, absent improvement in labor market indicators, much higher inflation, or a US Dollar crisis.

Book Review: Surveillance Nation

Wednesday, July 30th, 2014

Surveillance NationAfter I married my wife, I met her cousin and his wife, who was a Marxist.  Oddly, I found we had a lot of areas of agreement, because we both distrusted the powers that be.  In the same manner, what does a libertarian like me have to do with liberals like those who write for “The Nation?”

The answer is a lot.  There is a tendency for the political middle of the US to simply trust the politicians, assuming they are doing good. It is more accurate to assume that they are pursuing the goals of the ek=lite in the US.   The Wealthy will do well; the rest of us, meh.

We  need to be concerned about what data the government gathers on us, because it may infringe upon our constitutional rights.  Personally, I would end the CIA, NSA, and FBI.  Let chaos pursue us, and after that, let’s figure out what security we need.

I do not trust our government.  There is too much power, and too little transparency.

As for this book, it was prescient with respect to the US government collecting data on average citizens.  We live in an era when our actions are no longer private, unless we are rich enough and clever enough to conceal it.

I highly recommend this book.  It points out the errors of the US government as it aims toward secrecy, when it should disclose the information.

Quibbles

As time goes on the arguments verge from arguing for the common man, to arguing for the different man.

Summary

Many people would benefit from this book.  It will teach you about how we are all losing our freedom of speech bit-by-bit.  If you want to, you can buy it here: Surveillance Nation.

Full disclosure: The PR flack asked me if I would like a copy and I said “yes.”

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

 

On Learning Compound Interest Math

Saturday, July 19th, 2014

When I read articles like this where people get scammed borrowing money, I say to myself, “we need to teach children the compound interest math.”

Even my dear wife does not get it, and she sends the children to me when they don’t get it.  But beyond learning the math, a healthy skepticism of borrowing needs to be encouraged, especially for depreciating items like autos.

The compound interest math is really one of the more simple items of Algebra 2.  Everyone should be able to calculate the value of a non-contingent annuity at a given interest rate.

Once people learn that, they might have more skepticism regarding the long-dated pension-like promises that the government makes, because they can look at the future payment stream, and say, “I can’t see how we fund that.”

All for now.

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.


Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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