Well, look at the DJIA and Nasdaq Composite.? New 52-week highs.? I am still bearish on our credit markets, tepidly bullish on equities, particularly inflation-sensitive sectors (and insurance), and bearish on Real Estate and Real Estate finance.? This is a hard combo to hold together, but in some ways, I suspect that surplus capital that was making its way to the credit markets is now making its way to the equity markets.
I’m eclectic, what can I say?? I’m always trying to blend signals from the long-, intermediate-, and short-term, with greater emphasis to the longer cycle elements.? I’m not a trader.
Now, just a few notes to catch up on reader questions:
Why FSR and not VR or IPCR then?
I forgot about VR, and will have to consider it in the future.? I like IPCR, but it has run some recently, and their aggregate maximum loss discipline will limit their returns vs those companies that use probable maximum loss.
I think your post is very useful but that it raises some critical issues about successfully forecasting future inflation/real rates. Your study period includes a period where 3 major versions of CPI existing. There is the pre-Reagan CPI, the pre-Boskin CPI and the current. John Williams at shadow statistics calculates all three. The curren pre-Reagan CPI is running over 10% so ?real rates? based on that would be negative 6-7%! The pre-Boskin is I think 5-6% which would still produce negative real rates?.and the Fed is cutting rates!
I wish anyone luck trying to forecast 10 year hence real rates or inflation given this mix. My personal opinion is that due to fiat currencies they are likely to be much higher unless central banks allow a deflationary credit contraction to take force without trying to inflate. History suggests that they all try to inflate!
One thing that is different about my blog is that I will do different sorts of posts.? I’m hard to categorize. ? This comment makes some very good points, most of which I agree with.? I believe inflation is understated in the US, and I think that the idea is growing in the populace, while Ph.D. economists stay in lockstep with the guild, and deny it.? My main article on the topic, for those with access to RealMoney, can be found here.
Also, my main point was not to get people to try to forecast inflation and real interest rates.? It was to point out how changes in inflation and real interest rates disproportionately hurt equity investors compared to bond investors.? That said, it takes a large move in inflation rates to wipe out the ordinary advantage of equities.
Hi, how do you think i-bank incentive fees will effect EPS over the next year?
I worked for a technical trend following CTA in the 90?s that had a severe drawdown of -55% over the course of a year. It started with one bad day and the company was never even remotly profitable again and the owners closed it down 3 years later.
I think that people don?t understand that in order to make incentive fees the hedge funds have to make new highs, just being flat doesn?t cut it. Unless they are constantly making new highs, the hedge fund business is the same model as the mutual fund biz but with much higher overhead.
Alternatively they shut their existing funds down and open new ones to reset the mark but its hard to replace the truely large capital pools.
Interested in your thoughts.
That’s an interesting question.? With respect to compensation from internal hedge funds, there will be some loss of EPS.? That said, investment banks have more true technical information than most hedge funds, and will benefit from trading against funds that are in bad situations.
In general, most hedge funds that lose 25% of capital go out of business.? At 50%, almost all of them do.
That’s all for the evening.? Let’s see if the S&P 500 hits a new high on Tuesday.
Full disclosure: long FSR
Tickers mentioned: VR IPCR
Can you post the RealMoney article here? I don’t have a RealMoney subscription but am very interested in your detailed take.
Hello David,
Thank you for addressing my comment regarding CPI. I was not effective in communicating my main point. Your regression period runs over a period where one of your variables changed – i.e. how they calculate CPI. I would argue that to get a more statistically significant result you would have to regress using the same pre-Reagan CPI for the entire period. I’d be curious how the results would be impacted. I am nowhere near your expertise with regards to stats etc. so I may be totally off base!
Interesting analysis of the current state of the market. What makes you bullish on the insurers? I also am bullish on the group as a whole, but feel there are some who may lag the overall group noticably based upon the differences in execution.
I met David through Real Money (I’ve subscribed since inception). We are LUCKY that David blogs but you can learn a lot from that site.
James – You make great points as usual. (BTW do you have a blog somewhere)?
Wanted to throw something out re. Williams’ recalculations of the CPI. I am very sympathetic to the intent, but I don’t understand why the spread between the pre-Reagan version (which purports to back out use of rents instead of home prices, in addition to the Boskin stuff) and the pre-Boskin version (which just nets out the Boskin stuff) never seems to change. Home prices went from rising at double digit rates to falling — shouldn’t the spread between those two have narrowed or even gone negative?
Any thoughts?
Incidentally the Cleveland Fed’s median CPI seems to at least ignore the effects of the Boskin report. It tracks “regular” cpi quite well until the mid-90s, after which time it is typically higher. Still doesn’t include home prices though.
While I’m rambling, there is also the idea that “CPI growth” is the same as “inflation” — if inflation is defined as declining purchasing power, then inflation could show up anywhere, not just in the narrow basket of goods/services in the CPI.
thanks,
Rich
Paul — Yeah, I’m thinking of subscribing to RealMoney just to read more of David’s stuff — I can’t get enough! 🙂
Hello rich – thanks for the kind words. I do not have a blog but I do author a weekly commentary. I’d be happy to sign you up if you send me your email address off line. I’d prefer not to “market” on David’s blog without compensating him fairly, so if interested send me an email at my jucojames@hotmail.com address.
Personally, I think the entire western view of inflation is misdirected. I tend to be of the Austrian school which largely believes that inflation is credit creation. Whether under a hard money or fiat system, interest rates and currencies are the pricing mechanisms to try and price the cost of credit to be counter cyclical. Essentially, as risk preferences increase the cost of credit should increase.
Under our current fiat system interest rates are fixed at artificial levels and there are very small hurdles in place to prevent credit creation when risk preferences increase. The explosive growth of derivatives and off balance sheet (siv’s etc.) entities along with non-bank financials (hedge funds for example) have poured gasoline on the credit creation inferno. Credit has been expanding at dangerous rates globally. Credit creation can manifest in higher consumer prices AND/OR asset prices. It is simply ridiculous IMO to believe that almost all commodity prices, bond prices, real estate prices and equity prices globally could be appreciating at rapid rates well above global economic growth and not call it a symptom of the related global credit creation.
I think the pre-Reagan and pre-Boskin CPI’s are relatively stable because they are more closely linked with this credit creation rather than any piecemeal statistically tortured basket of consumer goods like the current CPI reflects. I would guess that they have been relatively stable because credit creation has been expanding at a fairly consistent rate.
Thanks James – I will drop you a line. Regarding the Shadowstats, I am in agreement with the general difficulties in forming a single price index, but even still it doesn’t seem that those two figures should be stable to each other.
Let?s look at it this way — this is how Williams would define the measures near as I can tell.
pre-Reagan == (original CPI)
pre-Boskin == (original CPI) + OER instead of home prices
current == (pre-Boskin) + Boskin commission stuff
So regardless of the difficulties of creating a single price index, it seems that the only statistical difference between William?s ?pre-Reagan? and ?pre-Boskin? numbers should be home prices. And so the spread between them should have been declining since mid-2005.
I might be misinterpreting the definitions of his different metrics, but if not, then it seems that he might have calculated a single average adjustment that gets consistently applied each month.
thanks,
rich