Month: August 2008

The Fundamentals of Market Bottoms, Part 3 (Final)

The Fundamentals of Market Bottoms, Part 3 (Final)

Posted on by David Merkel

12) Value investors find no lack of promising ideas, only a lack of capital.

13) Well-capitalized investors that rarely borrow, do so to take advantage of bargains.? They also buy sectors that rarely attractive to them, but figure that if they buy and hold for ten years, they will end up with something better.

14) Neophyte investors leave the game, alleging the the stock market is rigged, and put their money in something that they understand that is presently hot — e.g. money market funds, collectibles, gold, real estate — they chase the next trend in search of easy money.

15) Short interest reaches high levels; interest in hedged strategies reaches manic levels.

Changes in Corporate Behavior

1) Primary IPOs don’t get done, and what few that get done are only the highest quality. Secondary IPOs get done to reflate damaged balance sheets, but the degree of dilution is poisonous to the stock prices.

2) Private equity holds onto their deals longer, because the IPO exit door is shut.? Raising new money is hard; returns are low.

3) There are more earnings disappointments, and guidance goes lower for the future.? The bottom is close when disappointments hit, and the stock barely reacts, as if the market were saying “So what else is new?”

4) Leverage reduces, and companies begin talking about how strong their balance sheets are.? Weaker companies talk about how they will make it, and that their banks are on board, committing credit, waiving covenants, etc.? The weakest die.? Default rates spike during a market bottom, and only when prescient investors note that the amount of companies with questionable credit has declined to an amount that no longer poses systemic risk, does the market as a whole start to rally.

5) Accounting tends to get cleaned up, and operating earnings become closer to net earnings.? As business ramps down, free cash flow begins to rise, and becomes a larger proportion of earnings.

6) Cash flow at stronger firms enables them to begin buying bargain assets of weaker and bankrupt firms.

7) Dividends stop getting cut on net, and begin to rise, and the same for buybacks.

Other Indicators

1) Implied volatility is high, as is actual volatility. Investors are pulling their hair, biting their tongues, and retreating from the market. The market gets scared easily, and it is not hard to make the market go up or down a lot.

2)The Fed adds liquidity to the system, and the response is sluggish at best.? By the time the bottom comes, the yield curve has a strong positive slope.

No Bottom Yet

There are some reasons for optimism in the present environment.? Shorts are feared.? Value investors are seeing more and more ideas that are intriguing.? Credit-sensitive names have been hurt.? The yield curve has a positive slope.? Short interest is pretty high.? But a bottom is not with us yet, for the following reasons:

  • Implied volatility is low.
  • Corporate defaults are not at crisis levels yet.
  • Housing prices still have further to fall.
  • Bear markets have duration, and this one has been pretty short so far.
  • Leverage hasn’t decreased much.? In particular, the investment banks need to de-lever, including the synthetic leverage in their swap books.
  • The Fed is not adding liquidity to the system.
  • I don’t sense true panic among investors yet.? Not enough neophytes have left the game.

Not all of the indicators that I put forth have to appear for there to be a market bottom. A preponderance of them appearing would make me consider the possibility, and that is not the case now.

Some of my indicators are vague and require subjective judgment. But they’re better than nothing, and kept me in the game in 2001-2002. I hope that I — and you — can achieve the same with them as we near the next bottom.

For the shorts, you have more time to play, but time is running out till we get back to more ordinary markets, where the shorts have it tough.? Exacerbating that will be all of the neophyte shorts that have piled on in this bear market.? This includes retail, but also institutional (130/30 strategies, market neutral hedge and mutual funds, credit hedge funds, and more).? There is a limit to how much shorting can go on before it becomes crowded, and technicals start dominating market fundamentals.? In most cases, (i.e. companies with moderately strong balance sheets) shorting has no impact on the ultimate outcome for the company — it is just a side bet that will eventually wash out, following the fundamental prospects of the firm.

As for asset allocators, time to begin edging back into equities, but I would still be below target weight.

The current market environment is not as overvalued as it was a year ago, and there are some reasonably valued companies with seemingly clean accounting to buy at present.? That said, long investors must be willing to endure pain for a while longer, and take defensive measures in terms of the quality of companies that they buy, as well as the industries in question.? Long only investors must play defense here, and there will be a reward when the bottom comes.

=-=-=-=-=-=-=-==-=-=-=-=-=

That’s all for this post.? After comments are in, I will reformat the piece as one post and republish it.

Dissing/Praising the Recent Housing Bill

Dissing/Praising the Recent Housing Bill

Posted on by David Merkel

This post is not meant to be a fair rendering of the recent housing bill.? It is meant to be a rendering of its faults.? Part of the difficulty here is the effort that would go into reading page-by-page the whole document.? My guess is relatively few legislators read the full document, and even staffers would have had a hard time making their way through it.

Now for “unbiased” renderings, I offer you:

The basic rendering of the bill revolves around the following:

  • Help to Fannie Mae and Freddie Mac from the Treasury if they need it.? (Together with a supposedly stronger regulator)
  • Refinancing help for homeowners under stress from the FHA.
  • Grants for municipalities to buy abandoned properties.
  • Housing tax breaks, including a credit to first time buyers.
  • Money for pre-foreclosure counseling and legal services.
  • Some profits from Fannie and Freddie will build affordable rental housing.? (They already do this…)

Unfortunately, our dear government has a tendency to give with the right hand, and take with the left.

Beyond that, the hybrid nature of the GSEs is retained, which is a source of some of the troubles.? Mixed economic motives tend to lead to irrational decisionmaking, which implies credit losses.

Finally, I will close with the idea that condemnation and destruction of buildings is a lousy strategy.? It is lousy, because it would be better to allow for bidding on the part of private entities to use the building and space.? Why drop the value to zero, when you can take the valuable property, and put it to its best alternative use?

In summary, this bill will cost a lot less than its sticker price advertised to the American people.? There is lots of show, and less go.? Personally, that makes me thankful, because the budget can’t bear with aggressive programs that cost a lot.? It really looks like the Republicans won on this one, and that leaves me puzzled, because the Democrats should have had the upper hand.

The Fundamentals of Market Bottoms, Part 2

The Fundamentals of Market Bottoms, Part 2

Posted on by David Merkel

Before I get started for the evening, here is a copy of the Fed statements compared in PDF format, in case you couldn’t read it well on RSS.

Though this piece is about bottoms, not tops, I am going to use an old CC post of mine on tops to illustrate a point.


 David Merkel
Housing Bubblettes, Redux
10/27/2005 4:43 PM EDT

From my piece, “Real Estate’s Top Looms“:

Bubbles are primarily a financing phenomenon. Bubbles pop when financing proves insufficient to finance the assets in question. Or, as I said in another forum: a Ponzi scheme needs an ever-increasing flow of money to survive. The same is true for a market bubble. When the flow’s growth begins to slow, the bubble will wobble. When it stops, it will pop. When it goes negative, it is too late.

As I wrote in the column on market tops: Valuation is rarely a sufficient reason to be long or short a market. Absurdity is like infinity. Twice infinity is still infinity. Twice absurd is still absurd. Absurd valuations, whether high or low, can become even more absurd if the expectations of market participants become momentum-based. Momentum investors do not care about valuation; they buy what is going up, and sell what is going down.

I’m not pounding the table for anyone to short anything here, but I want to point out that the argument for a bubble does not rely on the amount of the price rise, but on the amount and nature of the financing involved. That financing is more extreme today on a balance sheet basis than at any point in modern times. The average maturity of that debt to repricing date is shorter than at any point in modern times.

That’s why I think the hot coastal markets are bubblettes. My position hasn’t changed since I wrote my original piece.

Position: none

I had a shorter way of saying it: Bubbles pop when cash flow is insufficient to finance them.? But what of market bottoms?? What is financing like at market bottoms?

The Investor Base Becomes Fundamentally-Driven

1) Now, by fundamentally-driven, I don’t mean that you are just going to read lots of articles telling how cheap certain companies are. There will be a lot of articles telling you to stay away from all stocks because of the negative macroeconomic environment, and, they will be shrill.

2) Fundamental investors are quiet, and valuation-oriented.? They start quietly buying shares when prices fall beneath their threshold levels, coming up to full positions at prices that they think are bargains for any environment.

3) But at the bottom, even long-term fundamental investors are questioning their sanity.? Investors with short time horizons have long since left the scene, and investor with intermediate time horizons are selling.? In one sense investors with short time horizons tend to predominate at tops, and investors with long time horizons dominate at bottoms.

4) The market pays a lot of attention to shorts, attributing to them powers far beyond the capital that they control.

5) Managers that ignored credit quality have gotten killed, or at least, their asset under management are much reduced.

6) At bottoms, you can take a lot of well financed companies private, and make a lot of money in the process, but no one will offer financing then.? M&A volumes are small.

7) Long-term fundamental investors who have the freedom to go to cash begin deploying cash into equities, at least, those few that haven’t morphed into permabears.

8) Value managers tend to outperform growth managers at bottoms, though in today’s context, where financials are doing so badly, I would expect growth managers to do better than value managers.

9) On CNBC, and other media outlets, you tend to hear from the “adults” more often.? By adults, I mean those who say “You should have seen this coming.? Our nation has been irresponsible, yada, yada, yada.”? When you get used to seeing the faces of David Tice and James Grant, we are likely near a bottom.? The “chrome dome count” shows more older investors on the tube is another sign of a bottom.

10) High quality companies keep buying back stock, not aggresssively, but persistently.

11) Defined benefit plans are net buyers of stock, as they rebalance to their target weights for equities.

I will try to complete this piece this week.? There should be one more part, and I will publish it all as one unit.

Fed Statements Compared

Fed Statements Compared

Posted on by David Merkel

Here’s a redacted version of the Fed’s statement today:

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

EconomicRecent information indicates that overall economic activity expanded in the second quarter,continues to expand, partly reflecting growthsome firming in consumerhousehold spending and exports.. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevatedthe rise in energy prices are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by The Committee expects inflation to moderate later this year and next year.? However, in light of the earliercontinued increases in the prices of energy and some other commodities, and the elevated state of some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but, uncertainty about the inflation outlook remains highly uncertain.high.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time. Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation are also of significant concern to the Committee.and inflation expectations have increased. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.

Quick Summary

  • Energy costs receding
  • Points at past easing indicating future stimulus (don’t expect more soon)
  • Highlights inflation risks
  • Many changes, but most of them are language tweaks and a little reorganization
  • Only one vote against
FOMC: Forking Out More Currency

FOMC: Forking Out More Currency

Posted on by David Merkel

Today’s FOMC meeting is largely a done deal.? No moves, but sound hawkish.? Personally, if I were in their shoes, I would move the Fed Funds target to 2.05%, just enough to weird the markets out, but not enough to do any real damage to those who rely on Fed Funds.? Creating uncertainty through breaking the convention on quarter percent moves would be good for the market, because market players have gained a false confidence over what the Fed can and can’t do.

The thing is, the Fed is boxed in, like many other central banks.? A combination of rising consumer prices, rising unemployment, and a weak financial sector will compel them to stay on the sidelines for now.

Now, as for Saturday’s post, I received a number of responses asking me to explain my views.? Here goes:

1) I’m not a gold bug; I have no investments in gold, or metals generally at present.? Any liking that I have for a gold standard is that it gets the government out of the business of manipulating the economy through manipulating the money supply.? Currency boards, pushed by my old professor, Dr. Steven Hanke, are another good idea.

2) Where am I on inflation/deflation?? We are experiencing goods and services price inflation, asset deflation, and a monetary system where the Fed is not increasing the monetary base, but the banks are expanding their liability structures over the last year, but that may have finally peaked.? Consider this graph:

There is a limit to how large the liabilities of the banking system can get relative to the Fed’s stock of high-powered money.? We reached that limit in the first four months of 2008, and now banks seem to be focusing on survival.

It is very hard to reflate bubbles — you can’t build an economy on sectors that are credit impaired, which makes me think that the housing stimulus ideas will likely fail.

3) The Fed is in a box.? They have no good policy options now.? They are stuck between rising (or at least high) inflation, rising unemployment, and the banks are not strong.? Fortunately the US Dollar has been showing a little more strength, but that’s probably anticipating the hawkish tone of today’s announcement.? If the statement is insufficiently hawkish, I would expect the US Dollar to weaken.

4) I expect goods inflation to persist in a moderate way over the intermediate-term, unless the main US Dollar pegs are broken (Gulf States, China).? Presently, we import a little of the inflation that the rest of the world is experiencing mainly through energy, and energy related commodities, like fertilizer.

5) Globalization does restrain wage growth on the low end.? On the high end, it is likely a benefit, and in the middle, probably neutral.? Those who benefit the most are those who are able to use relatively cheap labor for unskilled tasks.? But technological change also affects job prospects in different industries.? My view on steel is that the industry shrank mainly due to technological improvements at the lower cost mini-mills.

6) As for the GSEs, banks, and the investment banks, the Fed would be challenged to raise rates much.? At present, the positively sloped yield curve is allowing some banks to repair by borrowing short and lending long.? That is a good trade for now, but will be prone to trouble if the Fed ever concludes that it has to shift to fighting inflation, and not just put on a rhetorical show.

7) Finally, we have some degree of restiveness among the hawks on the FOMC.? I would expect two (or so) dissents favoring tightening today, but now with the current cast of ten (counting Elizabeth Duke, a banker), but if we get four, which is not impossible, I think it would unnerve the markets.? Mishkin is leaving at the end of August, and the custom is that he attends but does not vote at his last meeting.? (For more on FOMC dissents, I have this article.)

Well, let’s see what the FOMC has to say.? After all, at present, they are all talk.

Discounting Future Prospects

Discounting Future Prospects

Posted on by David Merkel

In one sense, among value managers, I’m an agnostic.? I am more than happy to analyze the theories of other value managers, and see how they can help me create an even better method for analyzing stocks.

But in the present environment, many value managers have gotten hit, and hard.? Thus the need for a Value Support Group.? I sympathize with their plight, but value has to be sought considering the likelihood of problems in earnings prospects.

Now, I’m not perfect, and sometimes after underperforming days like today, I wonder if I should be writing at all 🙂 , but part of being a value manager should be looking at the future prospects of the industry one is investing in.? Banks and other credit-sensitive financials are staple investments of value managers, because they are mature businesses, with good returns on equity under normal conditions.? Trouble is, conditions aren’t normal, and I can’t imagine how many times I beat the drum over at RealMoney, explaining from 2004-2007 why financials (away from insurers) would eventually have trouble.

As a value manager, I am doing well this year, because I largely avoided credit-sensitive names, and was more willing to believe that the economy wasn’t doing that badly.? Value investing means looking at both the long and short term prospects for an industry, as well as the valuation.? Industries that have gotten smashed on a price basis, but have reasonable long-term fundamentals can be a fruitful place to invest.? Industries with low P/Es, but have deteriorating fundamentals are usually bad places to invest.? Industries like newspapers, where the long-term fundamentals are bad, are bad places to invest, regardless of valuation, unless there are non-newspaper assets.

Ideally, I invest in industries that have been smashed, but the long term fundamentals are decent; I buy high quality names that can survive.? Less ideally, I buy companies that are relatively cheap, where trends are under-discounted.? This is not a perfect way to invest, but it does tend to yield good results over time, with a decent amount of noise in the results.

In summary, value investors should not be wedded to a few sectors, but should be willing to abandon sectors that were previously regarded as key if the situation is bleak enough, and valuations are too high.

Inflation for Goods Prices, Attempted Inflation for Housing-Related Assets, but Sorry, No Inflation for Wages

Inflation for Goods Prices, Attempted Inflation for Housing-Related Assets, but Sorry, No Inflation for Wages

Posted on by David Merkel

In the midst of a loosening cycle, the Fed keeps the monetary base flat.? This is not normal.? Instead, they use their high-quality balance sheet to bail out the liquidity problems of banks, broker-dealers, and maybe others, all while not expanding high powered money.? This is not normal, either.? After all, the Fed wants to heal the providers of badly underwritten credit (and increased their efforts last week, also here, here, and here), but they don’t want any liquidity to spill over into the general economy, because it might spark a wage-price spiral.

Consider the efforts of the Treasury toward Fannie, Freddie, the banks, and the housing market generally.? Yes, they are trying to avoid systemic risk, and that’s important.? But where is the support from the Fed and Treasury over unemployment, which is beginning to grow currently.? I’m not just talking about more unemployment, but about less compensation growth for labor in total.? Their focus is away from that, and looking at stabilizing a financial structure.? That’s good for all of us, but a disproportionate amount of the benefits goes to enterprises that made bad loans.? My rules of bailouts say that you must make bailouts painful to management teams and shareholders, while protecting senior debt, and thus preventing systemics risk.? That is not what is going on here.

I’m no great fan of central banking; I believe it makes our economy more stable in the short run, but intensifies crises when they take place (In my opinion, we never would have had the Great Depression if we had not created the Federal Reserve).? Life under a true gold standard has real panics, but they are sharp and short.

At present, we are setting the stage for an increase in unionization.? I am no fan of unions, but who can blame workers from seeking more bargaining power when they have had it rough for a long while?

My summary is that the policies of the Bernanke Fed are too clever.? Restrain wage/price inflation while bailing out banks and broker-dealers, Fannie, Freddie, etc.? But goods inflation keeps running ahead, and the oversupply of houses keeps forcing prices lower.? The actions of the Fed and Treasury protect the financial system for now, but at what eventual cost?? It might have been better for the Bernanke Fed to have been more traditional, and have stimulated the general economy, while letting the Treasury protect individual financial institutions in trouble.

I don’t think this will end well, but perhaps a recession like 1973-74? will clear the decks.? The Fed has to see that its main roles are price inflation and unemployment, with systemic risk third.? Any other way of prioritizing Fed action will lead to greater controversy in the long run.

Analyzing Growth in Firm Value

Analyzing Growth in Firm Value

Posted on by David Merkel

We’re nearing the end of second quarter earnings season, and I have have had my share of hits and misses, compared to the estimates that the sell side publishes.? What is the sell side?? The sell side is the analysts working for broker-dealers who publish research on companies, often estimating what they think they should earn in a quarter or year.? There is a buy side as well, which are analysts working for mutual funds, asset managers, etc., who analyze companies for their employers.

As investors, we are pelted with terms for corporate performance:

  • Comprehensive income — increase in net worth (approximately)
  • EBITDA? (Earnings before interest, taxes, depreciation and amortization) — what monies are the assets of the company generating in cash terms
  • Operating income — Net income, excluding one-time charges.
  • Net income — An attempt to show the repeatable increase in the value of the business, excluding the adjustments that operating income makes.? It also excludes “temporary differences” that are expected to reverse, which go into Accumulated Other Comprehensive Income on the balance sheet, and not through income.? An example would be unrealized capital losses on unimpaired credit instruments.

Which of these measurements should an investor use?

  • In takeovers, EBITDA is the most relevant, because it shows the cash generating capacity of the assets.
  • Operating income is the most relevant each quarter for companies that are going concerns.? It excludes “one time” events.
  • Over the long haul, accumulated net or comprehensive income is the most relevant, because all of the “one time” adjustments are aggregated.

In the short run, the adjustments that come from one-time events (mostly negative) can be tolerated.? But managements are supposed to try to control the factors that generate one-time events in the long run.? That part of their job.? If you have enough track record on a management team, you can sit down and calculate accumulated operating income less accumulated net income.? For good managements, that number is negative to a small positive.? For bad managements, it is a big positive.? I’ve seen estimates over a long-ish period of time, and the average difference between the two is around +5% — +10%.? That much typically goes up in smoke from operating earnings, never to reappear.

Now, some have toyed with adjusted dividend yield formulas, where they add back buybacks, and they use that as a type of true earnings yield.? After all, that reflects cash out the door for the benefit of shareholders.? True as far as it goes, but other uses of retained earnings aside from buybacks are valuable as well.

  • Buy/create a new technology, plant or equipment
  • Buy/create a new product line
  • Buy a competitor, or, a new firm that offers synergies
  • Buy/create a new marketing channel

In the hands of a good management team, these actions have value.? In the hands of bad management teams, little value to negative value.? So, I prefer earnings to these new measures based off dividends and buybacks for good management teams.? With a bad management team you want them to not have much spare capital for bad decisions, but would you trust the safety of the dividend and commitment to the buyback to a bad management team?? So, in general I prefer earnings, or, if calculable, free cash flow, to dividend/buyback metrics.

What is free cash flow?? The free cash flow of a business is not the same as its earnings. Free cash flow is the amount of money that can be removed from a company at the end of an accounting period and still leave it as capable of generating profits as it was at the beginning of the accounting period. Sometimes this is approximated by cash flow from operations less maintenance capital expenditures, but maintenance capex is not a disclosed item, and changes in working capital can reflect a need to invest in inventories in order to grow the business, not merely maintain it.

Ideally, free cash flow generation is what we shoot for, but it is difficult to estimate in practice.? When I took the CFA exams, the accounting text suggested that the goal of earnings was to reflect free cash flow to the greatest extent possible.? I’m not holding my breath here; I don’t think that goal is achieved or achievable.? To do that, we would have to have managers expense maintenance capex, and we would have to reflect the capital requirements of financial regulators as a cost of doing business for financial companies, and there are many more adjustments like those.

So, I like accumulated net income in the long run and operating earnings in the short run for measuring financial performance.? I’ll give you one more measure to consider which might be better.? From a not-so-recent CC post (point 2, rest snipped for relevance sake):


 David Merkel
Notes Before I Leave for ANother Series of Conferences
11/9/04 5:44 PM?ET
1. Be sure and read Howard’s piece “Hurricanes and the Limits of Rebuilding .” He comments more extensively on something I touched on when Frances was threatening Florida. Recovery from disasters often makes GDP look better afterward, because the destruction is not captured in the GDP statistics as a loss, save for the reduction in insurance profits, whereas the work of rebuilding does get fully captured.

2. The same idea can be applied to equity investing. This is why I pay attention to growth in book value per share, ex accumulated other comprehensive income, plus dividends, rather than earnings. Nonrecurring writedowns, charges for changes in accounting principles, and other adjustments, if they happen often enough, it makes a statement about the way a company handles accounting. Companies that are liberal in their accounting may have good looking earnings, but growth in book value per share can be quite poor. I trust the latter measure.

Growth in fully diluted tangible book value (ex-AOCI) is a good measure of firm performance, if you add back dividends, and subtract out net equity issuance/buyback measured not at cost, but at the current market price. Why the current market price?? Some managements buy back stock indiscriminately, not caring about the price at purchase.? That’s rarely a good idea.? Good management teams wait until their shares are near or below their estimate of fair value before they buy back.

Good management teams are also sparing/judicious with share and option grants.? Measuring the cost of the issuance/grants/dilution at the current market price penalizes the financial performance appropriately for what they have given away from shareholders equity per share all too cheaply.

So, that’s my preferred measure for how much has the underlying value of the firm increased: growth in fully diluted tangible book value (ex-AOCI), adding back dividends, and subtract out net equity issuance/buyback measured not at cost, but at the current market price.

There are things that this measure does not capture, though.? Look for places where assets are misstated on the balance sheet. E.g., property may be worth more or less than the carrying value.? Plant and equipment may be worth more or less than the carrying value.? Having a feel for the appreciation/depreciation in value, however slow, can be an aid to estimating the true change in value for a firm.

Estimating the true value of a firm’s earnings is challenging.? There is no one good measure; it depends on the question that you are trying to answer.? But knowing the outlines of of the problem helps in analyzing the earnings releases as they pelt us each quarter.

PS — I know I have excluded EVA, NOPAT, and other measures here.? Perhaps another day…

Mixing Red Delicious and Granny Smith Apples

Mixing Red Delicious and Granny Smith Apples

Posted on by David Merkel

When I first looked at this article, I thought “Hmm… another article showing that inflation is understated, and real growth overstated.”? But then I read this excerpt:

“That alleged 1.9 percent growth depended on the ludicrous assumption that inflation was just 1.1 percent at an annual rate,” said Stefan Karlsson, an economist based in Sweden.

“If you instead deflate the nominal GDP growth of 3.0 percent with the 4.3 percent increase in the gross domestic purchases deflator, then growth was -1.2 percent,” he wrote on his blog.

I thought it didn’t make sense, after all, every nominal growth figure has its own inflation rate (deflator).? Why cross the Gross Domestic [GD] Product nominal growth with [GD] Purchases deflator?? The GD Purchases deflator should correspond to the GD Purchases nominal growth rate.? GD Purchases grew at a nominal rate of 3.7%, for a real shrinkage of 0.5% annualized.? You can see the figures here on page 11, toward the bottom of the page on the right.

But, the article does have a point.? The figures for GD Product don’t contain the effects of import prices, like crude oil and other energy imports, and thus they portray a stronger economy.? If we are analyzing how the economy is treating consumers, i.e., are they consuming more on an inflation-adjusted basis?? Here are the last eight quarterly figures annualized: 2.0, 0.9, 0.2, 1.2, 2.9, 2.6, ?1.0, 0.1, and ?0.5%.? Over the last two years, that’s 1% annualized.? Pretty slow.? Over the last year, 0.3%, even slower.

Looking at the GD Purchases numbers, you can get a feel for why many consumers, particularly on the low end are feeling as if the economy isn’t doing much for them now.? A pity that the series isn’t better known.

Advice for the Connecticut Attorney General

Advice for the Connecticut Attorney General

Posted on by David Merkel

Is being Attorney General just a way of attracting attention as a modern Roman Tribune, a friend of the plebians, so that you can gain greater political power — in our system, run for Governor?? It sure seems that way at times, particularly when they go after large, complex corporations with seemingly a lot of market power.? My case tonight is the State of Connecticut versus the rating agencies.

The basic claim by Connecticut is antitrust, as Naked Capitalism points out.? That is hard to prove, but it is possibly the best case to make, even though I think it will still fail.? The main point to bring out is that the rating agencies earned extra money through their ratings of the financial guarantors, which were overrated, and allowed them and the financial guarantors to profit from the need for ratings and financial guarantee insurance.? And, as such the suit should be against both the financial guarantors and the rating agencies.

Delving into the expected loss differences between corporates and munis is probably not a fruitful line of argument, for two reasons: first, even though the rating agencies claimed the scales were comparable, the markets would say otherwise, the yields reflected greater risk.? Second, the muni market is more retail-oriented than the investment grade corporate market.? The retail investors are less diversified and more risk-averse, requiring a higher yield than corporate bond investors.

My experience has been that yields don’t merely reflect ratings but a broader array of risk factors.? I would hear from bond brokers who would say, “Hey, this bond trades cheap to the rating.”? I would often say, “Cheap for a reason.”? Ratings are guides, they aren’t infallible.

The Connecticut AG should be careful here.? His suit as currently constructed will fail, unless he shows that the journalistic speech of the rating agencies is at least partly driven by commercial concerns, and they implicitly profit through their symbiotic relationship with the financial guarantors, who were too highly rated for too long as a result.? And, as such, he should add MBIA and Ambac to his suit.? That would have a better chance of winning, but I still think they would not win.? It’s close enough to be worth a try, though.

Theme: Overlay by Kaira.