"We now know that the readings of last month were not a fluke or some temporary aberration that could be marked off as something related to the weather. There is quite obviously some serious financial stress manifesting in the data and this does not bode well for the growth of the economy going forward." - National Association of Credit Management report for March 2015
The Credit Managers' Index (CMI) is an index put together by the people paid to spot trouble early. Credit managers are the people that approve or reject applications for credit. Furthermore they are the same group that try to collect on the debt once it is issued. So this group has a very keen understanding of the health of the economy which is why I like to follow the index closely.
To give you a better understanding of the index it is based on a scale of 50. Anything that is higher than 50 means that the indicator is showing signs of health; a reading therefore less than 50 shows signs of strain. Back in 2008 the reading plunged from roughly 55 to 50 in a couple of months before then falling to 40 in the midst of the recession. Once again this reading has fallen from 55.1 to 51.2 in two months, a sever contraction not recorded since right before the previous recession. Prior to February the index had hovered around 55 for the past 5 years with moderate fluctuations but nothing serious. So in February when the index tested its lower boundary it was a concern but now that it has bust the bubble it could mean trouble is coming at a very rapid clip.
Digging into the numbers shows that while the number of applications for credit is rising, the number being rejected is growing faster. This means that the companies requesting the credit are struggling and are not strong enough financially to handle the additional credit so they are being turned away. Companies that could be given credit lines are not taking on more debt so the number is falling. This is creating a financial squeeze similar to that which occurred right before the previous contraction. With this type of financial squeeze going on it is only a matter of time before a number of bankruptcies are announced but for now this is one number that has yet to fall into the negative category.
The ripple effect of these bankruptcies will be felt throughout industry as these debts that were previously recorded as either performing loans or accounts receivable will have to be written off creating an overall contraction of credit and a strain on company and bank cash flows. The problem this time around is that the Federal Reserve has already spent $4 trillion getting us nowhere so announcing another round of quantitative easing while more likely than not, will not help alleviate the stresses caused by a weak business environment. What it could do is once again ignite the currency warfare and drive not only Europe but the rest of the world into a recession.
Keep your eyes on this indicator as it does not normally flash red unless there is a real danger ahead.
Friday, April 24, 2015
Friday, April 17, 2015
A $2 Trillion Hand Brake
"I couldn't repair your brakes so I made your horn louder." - Unknown
In a fascinating article in the Economist Magazine entitled "The paradox of soil", the authors put forth that the cost of strict land regulation in major metropolitan areas around the world is like a hand brake on economic growth. In the United States it is estimated that the lost GDP is around 13% a year or $2 Trillion. This is a very large number and unlocking this blockage would result in significant benefits to society and economic growth.
In the past restricting land development, particularly in large metropolitan areas, was thought prudent due to the inherent slums and poor living standards that urban sprawl created. Through the years land development controls were put into place to restrict development so that these problems were eradicated. Fast forward to today and these controls have now moved far past the median and are creating enormous drags on economic growth. Removing or streamlining a significant portion of these over burdensome controls is the key to unlocking significant economic gains.
In the past it was thought that technology would make cities obsolete. Workers would be able to work anywhere so there would be a tendency to relocate out of the cities to cheaper more remote places. It turns out that the opposite is true. Major metropolitan areas create brain pools that cannot be replicated elsewhere. People living in these brain pools are stimulated by their peers in ways that cannot be replicated moving away. For this reason cities like London and San Francisco continue to attract people while the outlying areas remain a backwater.
Furthermore it is shown that due to the concentration of people in the metropolitan areas a large swath of wealth inequality occurs in these cities as landlords receive a larger proportion of income on their land holdings that those who own similar tracts of land outside of these areas. The impact is even larger when you consider that as the rent rises the poor are pushed further from the city center, away from the brain pool and this further out of the main stream. This inability to partake in the activities of the main stream expands the inequality and forges a barrier to entry.
In addition, as the cost to living in these cities increases people that are living on the margin of prosperity leave the city in search of a better quality of living elsewhere. As we have seen above, leaving the brain pools reduces their productivity thereby slowing economic growth and pulling harder on the economic hand brake.
I have to say that I am living through the nightmare that is city planning and development in that I have spent the past 4 years trying to get a 22 unit parking lot built downtown San Diego. Now I will be the first to admit that this is not the type of expansive land use that the authors of the article are promoting but when you consider that after 4 years I still do not have the necessary permits issued you can see immediately the drag on economic growth. Were it easier to obtain permitting I would have considered building an apartment complex (which is exactly what the authors think will lead to greater economic growth) but who knows how long that would have taken and how much it would have cost.
So while I believe that some land development restrictions are required to ensure green areas and healthy living standards for all, loosening the strangle hold that is strict developmental control and allowing development to occur would have an immediate and direct impact on the economic outlook to not only the city but the nation as a whole and that should be a high priority in all cities across the globe.
In a fascinating article in the Economist Magazine entitled "The paradox of soil", the authors put forth that the cost of strict land regulation in major metropolitan areas around the world is like a hand brake on economic growth. In the United States it is estimated that the lost GDP is around 13% a year or $2 Trillion. This is a very large number and unlocking this blockage would result in significant benefits to society and economic growth.
In the past restricting land development, particularly in large metropolitan areas, was thought prudent due to the inherent slums and poor living standards that urban sprawl created. Through the years land development controls were put into place to restrict development so that these problems were eradicated. Fast forward to today and these controls have now moved far past the median and are creating enormous drags on economic growth. Removing or streamlining a significant portion of these over burdensome controls is the key to unlocking significant economic gains.
In the past it was thought that technology would make cities obsolete. Workers would be able to work anywhere so there would be a tendency to relocate out of the cities to cheaper more remote places. It turns out that the opposite is true. Major metropolitan areas create brain pools that cannot be replicated elsewhere. People living in these brain pools are stimulated by their peers in ways that cannot be replicated moving away. For this reason cities like London and San Francisco continue to attract people while the outlying areas remain a backwater.
Furthermore it is shown that due to the concentration of people in the metropolitan areas a large swath of wealth inequality occurs in these cities as landlords receive a larger proportion of income on their land holdings that those who own similar tracts of land outside of these areas. The impact is even larger when you consider that as the rent rises the poor are pushed further from the city center, away from the brain pool and this further out of the main stream. This inability to partake in the activities of the main stream expands the inequality and forges a barrier to entry.
In addition, as the cost to living in these cities increases people that are living on the margin of prosperity leave the city in search of a better quality of living elsewhere. As we have seen above, leaving the brain pools reduces their productivity thereby slowing economic growth and pulling harder on the economic hand brake.
I have to say that I am living through the nightmare that is city planning and development in that I have spent the past 4 years trying to get a 22 unit parking lot built downtown San Diego. Now I will be the first to admit that this is not the type of expansive land use that the authors of the article are promoting but when you consider that after 4 years I still do not have the necessary permits issued you can see immediately the drag on economic growth. Were it easier to obtain permitting I would have considered building an apartment complex (which is exactly what the authors think will lead to greater economic growth) but who knows how long that would have taken and how much it would have cost.
So while I believe that some land development restrictions are required to ensure green areas and healthy living standards for all, loosening the strangle hold that is strict developmental control and allowing development to occur would have an immediate and direct impact on the economic outlook to not only the city but the nation as a whole and that should be a high priority in all cities across the globe.
Friday, April 10, 2015
When will the Bull market end?
"As a bull market continues, almost anything that you but goes up. It makes you feel like investing in stocks is very easy and safe and that you're a financial genius." - Ron Chernow
I am repeatedly asked when I think the Bull market will end so it was interesting when I read a blog article today written back in November 2013 by Manley Market Insight where he answered the question by pointing to three reasons for a possible decline: 1) the Federal Reserve adopts a restrictive monetary policy; 2) sales and earnings decline sharply without prompting from the Federal Reserve; and, 3) valuations become too high and collapse on their own weight.
I completely agree with him but it appears to me that we do not only have one of these problems but all three. Right now we have a Federal Reserve that has stopped printing money and is hinting at raising interest rates (restrictive monetary policy); corporate sales have been declining for a while and the US Commerce Department announced that in Q4 2014 corporate profits fell 3% and are on pace to decline again in the first quarter of 2015; and no matter what market metric you look at the market is way overvalued. In fact the market is at its second highest level in its history. With trading volumes dropping and the length of the bull market at six years already almost twice as long as the average bull market, it appears to me that we may have a triple play brewing.
A lot of the cause of this is the recent strength of the US dollar. The vast majority of the fortune 500 rely on expansion and growth in markets outside of the Untied States and with weakness in foreign currencies and countries, sales growth and profits are being hit. Even the benefit of the lower oil price is muted as consumers are not only saving the extra cash but they have not really felt the full impact as prices at the pump have risen by almost 20% during the last two months. Volatility is also picking up with the most 1% daily moves since Q4 2011 right before the last 10% correction.
With all of the poor economic news coming out of Europe, Asia and South America I cannot imagine that the Federal Reserve will be dumb enough to raise rates any time soon. In fact the one thing that no-one is talking about is the next round of quantitative easing from the Federal Reserve. Personally I expect more easing before any type of interest rate increase. In fact I expect that this year there will be a 10% plus correction in the market that will force the Federal Reserve to inject more stimulus into the economy. Unfortunately the type of stimulus that they are akin to use has never worked and hence it will be more futility and cause a larger problem later, however it will have the effect of stimulating the market to possibly new highs.
As I have mentioned above the market is on a seriously rocky road and the stimulus is not a fix but rather a larger problem. If you are looking for a place at which to sell, this might be a good time to diversify out of the market and head to distant shores.
I am repeatedly asked when I think the Bull market will end so it was interesting when I read a blog article today written back in November 2013 by Manley Market Insight where he answered the question by pointing to three reasons for a possible decline: 1) the Federal Reserve adopts a restrictive monetary policy; 2) sales and earnings decline sharply without prompting from the Federal Reserve; and, 3) valuations become too high and collapse on their own weight.
I completely agree with him but it appears to me that we do not only have one of these problems but all three. Right now we have a Federal Reserve that has stopped printing money and is hinting at raising interest rates (restrictive monetary policy); corporate sales have been declining for a while and the US Commerce Department announced that in Q4 2014 corporate profits fell 3% and are on pace to decline again in the first quarter of 2015; and no matter what market metric you look at the market is way overvalued. In fact the market is at its second highest level in its history. With trading volumes dropping and the length of the bull market at six years already almost twice as long as the average bull market, it appears to me that we may have a triple play brewing.
A lot of the cause of this is the recent strength of the US dollar. The vast majority of the fortune 500 rely on expansion and growth in markets outside of the Untied States and with weakness in foreign currencies and countries, sales growth and profits are being hit. Even the benefit of the lower oil price is muted as consumers are not only saving the extra cash but they have not really felt the full impact as prices at the pump have risen by almost 20% during the last two months. Volatility is also picking up with the most 1% daily moves since Q4 2011 right before the last 10% correction.
With all of the poor economic news coming out of Europe, Asia and South America I cannot imagine that the Federal Reserve will be dumb enough to raise rates any time soon. In fact the one thing that no-one is talking about is the next round of quantitative easing from the Federal Reserve. Personally I expect more easing before any type of interest rate increase. In fact I expect that this year there will be a 10% plus correction in the market that will force the Federal Reserve to inject more stimulus into the economy. Unfortunately the type of stimulus that they are akin to use has never worked and hence it will be more futility and cause a larger problem later, however it will have the effect of stimulating the market to possibly new highs.
As I have mentioned above the market is on a seriously rocky road and the stimulus is not a fix but rather a larger problem. If you are looking for a place at which to sell, this might be a good time to diversify out of the market and head to distant shores.
Friday, April 3, 2015
Rethinking Bonds
"He behaved like an ostrich and put his head in the sand thereby exposing his thinking parts." - George Carman
Plenty of investors have portfolios with a large allocation to bonds. It is the part of the portfolio that is considered safe and the base for creating a sustainable retirement. With rates at historic lows the main issue with a bond portfolio is reinvestment risk. This is the risk that some of your longer dated higher coupon bonds are maturing. The proceeds, if they are reinvested into similar longer term bonds, yield next to nothing. The reinvested dollars yield a very low amount creating havoc with a retiree's income.
In the modern world where financial companies are constantly trying to show the world that retirement is easy, millions of people are pouring billions of dollars into target dated funds, The idea is a nice one (and I use nice in its true sense meaning a fair idea with limited merit) but the problem is that it automatically shifts the needle on allocations more heavily into bonds as you age. This is creating a lower overall portfolio return and is not producing the desired returns impacting the ability to retire.
Rather than blindly following the herd pull your head out of the sand and survey the investment scene. First thing to do in a low interest environment is to look for places where there is yield. When you find it make sure that you are not accepting too much risk for the return. As most high yielding (and I am thinking in the neighborhood of 6% and higher here) investments are fraught with danger there are limited opportunities in this market to find the safe haven required by your retirement funds.
Assuming that you are unable to find a safe investment yielding anything of significance the next thing to do is to invest in shorter term bonds. I would not look out much further than two or three years. I know that you will be giving up some yield as short term rates are lower than long term rates but the difference is marginal. One or two percent difference will have a powerful impact on your portfolio over the long run due to the power of compounding however if rates start to rise then the drop in value of the long term bond would mean you are either stuck in that low interest investment or you have to take a far larger hit to your portfolio by selling the bond at a large loss. This to me means that you should rather earn a lower rate for the short run in order to participate in a larger rate of return later in the cycle.
The last thing you can do is reduce your allocation to bonds and focus on other parts of the market that can provide the boost your portfolio needs. One place to look is the stock market and this is touted by the "experts" as the only place to look but finding high yielding stocks is not easy and most of these stocks come with a double dose of risk; possibly cutting the dividend in poor times and/or falling precipitously from their current highs. To me this risk is the same as the higher yielding high risk bond investments. So you will have to look further afield to find returns and yields that match the requirements of your portfolio. One of these places is the property market where there are some parts of the country that can produce relatively high returns on investment with the safety of a free and clear property. Outside of this keeping this part of your portfolio secure while mitigating risk is becoming ever more difficult but one thing is for sure you will need to take some responsibility and control of your investments as we all know what happens when the blind lead the blind!
Plenty of investors have portfolios with a large allocation to bonds. It is the part of the portfolio that is considered safe and the base for creating a sustainable retirement. With rates at historic lows the main issue with a bond portfolio is reinvestment risk. This is the risk that some of your longer dated higher coupon bonds are maturing. The proceeds, if they are reinvested into similar longer term bonds, yield next to nothing. The reinvested dollars yield a very low amount creating havoc with a retiree's income.
In the modern world where financial companies are constantly trying to show the world that retirement is easy, millions of people are pouring billions of dollars into target dated funds, The idea is a nice one (and I use nice in its true sense meaning a fair idea with limited merit) but the problem is that it automatically shifts the needle on allocations more heavily into bonds as you age. This is creating a lower overall portfolio return and is not producing the desired returns impacting the ability to retire.
Rather than blindly following the herd pull your head out of the sand and survey the investment scene. First thing to do in a low interest environment is to look for places where there is yield. When you find it make sure that you are not accepting too much risk for the return. As most high yielding (and I am thinking in the neighborhood of 6% and higher here) investments are fraught with danger there are limited opportunities in this market to find the safe haven required by your retirement funds.
Assuming that you are unable to find a safe investment yielding anything of significance the next thing to do is to invest in shorter term bonds. I would not look out much further than two or three years. I know that you will be giving up some yield as short term rates are lower than long term rates but the difference is marginal. One or two percent difference will have a powerful impact on your portfolio over the long run due to the power of compounding however if rates start to rise then the drop in value of the long term bond would mean you are either stuck in that low interest investment or you have to take a far larger hit to your portfolio by selling the bond at a large loss. This to me means that you should rather earn a lower rate for the short run in order to participate in a larger rate of return later in the cycle.
The last thing you can do is reduce your allocation to bonds and focus on other parts of the market that can provide the boost your portfolio needs. One place to look is the stock market and this is touted by the "experts" as the only place to look but finding high yielding stocks is not easy and most of these stocks come with a double dose of risk; possibly cutting the dividend in poor times and/or falling precipitously from their current highs. To me this risk is the same as the higher yielding high risk bond investments. So you will have to look further afield to find returns and yields that match the requirements of your portfolio. One of these places is the property market where there are some parts of the country that can produce relatively high returns on investment with the safety of a free and clear property. Outside of this keeping this part of your portfolio secure while mitigating risk is becoming ever more difficult but one thing is for sure you will need to take some responsibility and control of your investments as we all know what happens when the blind lead the blind!
Subscribe to:
Posts (Atom)
