"I made something out of nothing, thanks for nothing." - Lil Wayne
I have to say that one of my favorite holidays in the United States is Thanksgiving. Not only is the food delicious but it essentially marks the end of the year as the mood generally changes in preparations for the coming holidays. In the small business community in which I operate it seems that there is a general sense of relief that we made it through another year. The giving of thanks is more about another year of survival than a celebration of massive profits. Obviously this is painted with a very broad brush as some businesses had a breakout year but overall small business has still not felt the full impact of the "recovery".
While big business has had a banner fiver year stretch small businesses have continued to struggle. In another article highlighting the woes of small business it was revealed that banks have reduced their lending to small businesses this year from 58% of originated loans in 2009 to 43% this year. The majority of small businesses therefore have to look beyond the normal avenues for sources of capital and while the capital is available it comes at a price. Typically there is a spread of at least 5% over a bank loan and a private loan and often it is far higher than this. For companies that are not showing profits or assets to use to secure the loans rates can rival those of credit card debt.
This drag is having a massive impact not only on their earnings but on growth prospects. Consider a company requiring $1M that has to borrow at 12% instead of 3%. The increase in the cost of interest equals two full time employee's salaries. Assuming that the business requires the money for growth prospects there is a high probability that the goals will not be achieved as they will either have to be met in a far shorter time frame than originally intended or they will have to try to make the target with fewer employees. Neither of these prospects are encouraging and reduces significantly the chances of success. In contrast the large business with access to limitless capital in the form of loans and stock issues can not only take advantage of opportunities but also has the luxury of time to let the idea develop and flourish.
As I have mentioned repeatedly in previous blogs, until this landscape changes from completely skewed in favor of large business, GDP growth will not only stagnate but be highly prone to economic shocks from outside the United States. So while large business deals with the prospects of slowing revenue and lower profits they can at least be thankful of those whereas the small business owner sees more heavy sledding ahead with no end in sight. Little incentive to start a small business and often times too little incentive to carry on plodding. For those of you in small businesses or just starting a small business I applaud you and give thanks for your perseverance and wish you much success for 2016!
Friday, November 27, 2015
Friday, November 20, 2015
The Credit Cycle
In a very interesting article in the Economist Magazine the flow of debt was followed from banks to consumers to businesses and countries. Studies were highlighted showing that debt burdens on consumers has a far larger impact on growth than debt held at businesses. Furthermore it was shown that emerging economies are more prone to economic shocks due to swift changes in debt levels however these countries can be split further into those with current account deficits and low levels of foreign capital versus those with current account surpluses and large foreign reserves. The former is subject to large swings in its economic fortunes and the value of its currency versus the latter who can weather the storm. This subset can be further divided into open economies and controlled economies with the former more readily able to shed the dead wood versus controlled economies that can drag bad debt along like an anchor for years.
As an example China, a controlled economy, keeps lumping more and more debt onto poorly run and money losing state enterprises creating a drag on economic growth. The money spent could easily be used to create jobs and economic benefit elsewhere. In contrast countries such as the United States are relatively good at letting bad investments die however this will be sorely tested during the next recession as the problem of too big to fail will once put into question political stomach versus the economic merit of holding onto poorly run enterprises.
As the United States' thinks about raising interest rates this is sending shock waves through the emerging markets particularly those economies like Brazil which are prone to runs on its capital reserves. An interest rate rise should propel the dollar higher resulting in a larger burden on Brazil to pay its dollar denominated debt and making the Real fall in value. This will be exacerbated by a flow of capital out of Brazil dragging the economy into a recession.
Now back in the good old days that would not have mattered much to the first world economies but in 2015 emerging markets make up the lions share of global GDP. In fact they are approaching 60% of the world's GDP. In addition they are the engine of global growth able to produce sustained periods of growth well above 5%. This type of GDP growth has not been seen in developed economies in decades and more than likely will never be witnessed again. So if the world is to exit from the cycle of growing debt levels the only way out that I can see is for global GDP to grow at a rapid pace and the only place that this will come from is the emerging markets.
As I have mentioned before while the United States believes that it is in good enough shape to raise rates it cannot withstand a sharp slowdown in emerging economies growth rates. For this reason while the Federal Reserve may be stupid enough to raise rates next month they will not have the latitude to continue to move them higher as the repercussions of a strengthening dollar will undermine any form of global recovery forcing them to end the interest rate increases. Worse still as the debt funnels back from emerging economies to the United States the result might be that the world's debt crisis may end up right back where it all started, in the hands of the Federal Reserve and that would be worrisome!
As an example China, a controlled economy, keeps lumping more and more debt onto poorly run and money losing state enterprises creating a drag on economic growth. The money spent could easily be used to create jobs and economic benefit elsewhere. In contrast countries such as the United States are relatively good at letting bad investments die however this will be sorely tested during the next recession as the problem of too big to fail will once put into question political stomach versus the economic merit of holding onto poorly run enterprises.
As the United States' thinks about raising interest rates this is sending shock waves through the emerging markets particularly those economies like Brazil which are prone to runs on its capital reserves. An interest rate rise should propel the dollar higher resulting in a larger burden on Brazil to pay its dollar denominated debt and making the Real fall in value. This will be exacerbated by a flow of capital out of Brazil dragging the economy into a recession.
Now back in the good old days that would not have mattered much to the first world economies but in 2015 emerging markets make up the lions share of global GDP. In fact they are approaching 60% of the world's GDP. In addition they are the engine of global growth able to produce sustained periods of growth well above 5%. This type of GDP growth has not been seen in developed economies in decades and more than likely will never be witnessed again. So if the world is to exit from the cycle of growing debt levels the only way out that I can see is for global GDP to grow at a rapid pace and the only place that this will come from is the emerging markets.
As I have mentioned before while the United States believes that it is in good enough shape to raise rates it cannot withstand a sharp slowdown in emerging economies growth rates. For this reason while the Federal Reserve may be stupid enough to raise rates next month they will not have the latitude to continue to move them higher as the repercussions of a strengthening dollar will undermine any form of global recovery forcing them to end the interest rate increases. Worse still as the debt funnels back from emerging economies to the United States the result might be that the world's debt crisis may end up right back where it all started, in the hands of the Federal Reserve and that would be worrisome!
Friday, November 13, 2015
The Pulse of the Global Market
"We have to choose between a global market driven by calculations of short term profit, and one which has a human face." - Kofi Annan
"No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable." - Adam Smith
With the world seemingly getting smaller by the day and global trade having an ever larger impact on local markets and economies I thought that this week I would revisit the pulse of the global market; that is to take a look at indicators that print the health of the global economy. The three main indicators that I look at are the price of oil, the price of copper and the daily price of dry bulk shippers. All three of these indicators are global in nature; oil is obvious, copper as I have mentioned in previous blogs represents industrial growth and dry bulk shipping rates show the level of international trade. While all three prices are driven by demand and supply inputs they are more prone to demand side shocks than changes in supply making them as close to a perfect pulse on the global market as is available.
To rephrase the above comment while the number of say dry bulk ships can be reduced or not replaced, it takes years for this slow drip method to take effect. Furthermore it takes at least a year or two to build a ship so some are still coming onto the market that were ordered years ago adding to supply even as demand falls. The result is that the market slowly reduces the number of ships while demand quickly adjusts to changes in global growth or contraction. This same equation holds true of copper and oil which is why these indicators contain within their prices the pulse of the global economy.
The first chart is the daily price change in Crude Oil. As you can see crude hit a low around $39 a barrel in late August. This was touted as the bottom of the market and a recovery was imminent. Subsequently there was a trading rally but this was met with resistance around $51 a barrel and now it looks like lows are about to be broken. Certainly not an indication of global demand and resilience.
The next chart is the copper price. As you can see the price of copper, like crude tried to rally late August but not only has it rolled over it has broken below its August lows and appears to be heading lower. This is a reflection in large part of the weakness in China but it is a clear indication of global economic weakness.
The final chart is the Baltic Dry Shipping Index. This is the daily rate that dry bulk shippers can demand from their clients. As you can see there is limited demand for dry bulk shippers and this index has not come close to recovering from its 2009 highs and is once again in a clear downward trend.
Based on the above snap shot of global trade it is clear that global economic growth is anemic and should make you wonder why the market will jump from here to new highs. To me it seems obvious that earnings will remain lackluster for the foreseeable future keeping the Federal Reserve at bay in regards to interest rate hikes and could result in a significant contraction in the value of equities which have become increasingly expensive as earnings contract. Until these indicators start to show signs of life my advice would be to remain on the sidelines. As the old trading adage says, "Do not try to catch a falling knife!"
"No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable." - Adam Smith
With the world seemingly getting smaller by the day and global trade having an ever larger impact on local markets and economies I thought that this week I would revisit the pulse of the global market; that is to take a look at indicators that print the health of the global economy. The three main indicators that I look at are the price of oil, the price of copper and the daily price of dry bulk shippers. All three of these indicators are global in nature; oil is obvious, copper as I have mentioned in previous blogs represents industrial growth and dry bulk shipping rates show the level of international trade. While all three prices are driven by demand and supply inputs they are more prone to demand side shocks than changes in supply making them as close to a perfect pulse on the global market as is available.
To rephrase the above comment while the number of say dry bulk ships can be reduced or not replaced, it takes years for this slow drip method to take effect. Furthermore it takes at least a year or two to build a ship so some are still coming onto the market that were ordered years ago adding to supply even as demand falls. The result is that the market slowly reduces the number of ships while demand quickly adjusts to changes in global growth or contraction. This same equation holds true of copper and oil which is why these indicators contain within their prices the pulse of the global economy.
The first chart is the daily price change in Crude Oil. As you can see crude hit a low around $39 a barrel in late August. This was touted as the bottom of the market and a recovery was imminent. Subsequently there was a trading rally but this was met with resistance around $51 a barrel and now it looks like lows are about to be broken. Certainly not an indication of global demand and resilience.
The next chart is the copper price. As you can see the price of copper, like crude tried to rally late August but not only has it rolled over it has broken below its August lows and appears to be heading lower. This is a reflection in large part of the weakness in China but it is a clear indication of global economic weakness.
The final chart is the Baltic Dry Shipping Index. This is the daily rate that dry bulk shippers can demand from their clients. As you can see there is limited demand for dry bulk shippers and this index has not come close to recovering from its 2009 highs and is once again in a clear downward trend.
Based on the above snap shot of global trade it is clear that global economic growth is anemic and should make you wonder why the market will jump from here to new highs. To me it seems obvious that earnings will remain lackluster for the foreseeable future keeping the Federal Reserve at bay in regards to interest rate hikes and could result in a significant contraction in the value of equities which have become increasingly expensive as earnings contract. Until these indicators start to show signs of life my advice would be to remain on the sidelines. As the old trading adage says, "Do not try to catch a falling knife!"
Friday, November 6, 2015
Heterogeneity Stumps the Fed
Heterogeneity - the state of being heterogeneous; composition from dissimilar parts; disparetness.
Ceteris paribus (Latin for "with other things remaining the same") was one of the favorite terms used when I was studying economics and it appears that not only is the Federal Reserve reliant on this phrase but they are also using the other economic theory of all people acting rationally. Neither of these ever works in the real world but economists love to try theories based not on real world examples but based on ceteris paribus in an effort to prove the impact of a change in one economic variable. This is akin to data mining, digging for data that proves your point even though the two variables are often not even vaguely related, but it is becoming more and more apparent that something as simple as Heterogeneity is stumping the Federal Reserve for the simple reason that they seem to rely on ceteris paribus and rationalism.
Heterogeneity essentially says that people will act differently from one another given a set of economic variables. The Federal Reserve does not seem to consider this when making their policy decisions as if they did then I would expect their decisions to be very different. Without digging too deep into the subject let's take a look at their current policies of low interest rate and money stimulus. The idea was that if you hold interest rates low and pump trillions into the economy through the reserve banking system that individuals would not hold onto cash but would load up on debt and invest the proceeds creating businesses and jobs. All you had to do was dump enough money into the top of the funnel and it would eventually trickle down to the man on the street. Voila, simple as that and hey presto all is well. (Sorry I could not resist the kitsch phrases as to me they highlight the lunacy of the decision making process. Who knows maybe they use these words behind closed doors as how else can they hatch such a poor plan?)
Years later and trillions of dollars they are still scratching their heads as to why this ridiculous plan has not worked but it is as simple as heterogeneity. People do not act in one massive unified body and, changing one variable, interest rates, does not make another variable, high debt levels, magically vanish. The results of this massive stimulus project has been to create what is turning into another stock market bubble and one of the largest wealth divides in history with such feeble economic footing that the economy cannot even handle 1/4 of 1 percent increase in rates..
As I pointed out a few weeks ago the velocity of money is at an all time low for the simple reason that people are not spending money. As the vast majority of individuals are earning less today (in inflation adjusted numbers) than they were a decade ago and as the labor participation rate is at a 38 year low, it is no wonder that there is little to no economic benefits coming from more Fed stimulus. People act within their own personal constraints and the lower end of the labor market has not seen any economic recovery and is still struggling to recover from the last economic meltdown. Until they feel the benefit of an economic recovery throwing more stimulus at an overvalued stock market will not get the job done and raising rates will kill the supposed golden goose.
Had the Federal Reserve and the government spent their time and money looking at how to get the labor participation rate up rather than making fat Wall Street bankers fatter I would argue that the economy would be on solid footing. Simple examples to get money into the hands of the low earners would be to stimulate small business growth with tax incentives and lower reporting requirements, provide students with no interest on their student loans while sending a rebate check to those that just fell outside of this benefit and spend money on roads and infrastructure projects to name a few. Doing this would mean more jobs, resulting in more money in the hands of those that would spend the extra income, improving consumer confidence and an economy not reliant on zero interest rates. For now though their focus is on more stimulus and while their numbers seem to show success the global economy and company earnings are pointing in the opposite direction which is why my money stands on the sideline watching and waiting.
Ceteris paribus (Latin for "with other things remaining the same") was one of the favorite terms used when I was studying economics and it appears that not only is the Federal Reserve reliant on this phrase but they are also using the other economic theory of all people acting rationally. Neither of these ever works in the real world but economists love to try theories based not on real world examples but based on ceteris paribus in an effort to prove the impact of a change in one economic variable. This is akin to data mining, digging for data that proves your point even though the two variables are often not even vaguely related, but it is becoming more and more apparent that something as simple as Heterogeneity is stumping the Federal Reserve for the simple reason that they seem to rely on ceteris paribus and rationalism.
Heterogeneity essentially says that people will act differently from one another given a set of economic variables. The Federal Reserve does not seem to consider this when making their policy decisions as if they did then I would expect their decisions to be very different. Without digging too deep into the subject let's take a look at their current policies of low interest rate and money stimulus. The idea was that if you hold interest rates low and pump trillions into the economy through the reserve banking system that individuals would not hold onto cash but would load up on debt and invest the proceeds creating businesses and jobs. All you had to do was dump enough money into the top of the funnel and it would eventually trickle down to the man on the street. Voila, simple as that and hey presto all is well. (Sorry I could not resist the kitsch phrases as to me they highlight the lunacy of the decision making process. Who knows maybe they use these words behind closed doors as how else can they hatch such a poor plan?)
Years later and trillions of dollars they are still scratching their heads as to why this ridiculous plan has not worked but it is as simple as heterogeneity. People do not act in one massive unified body and, changing one variable, interest rates, does not make another variable, high debt levels, magically vanish. The results of this massive stimulus project has been to create what is turning into another stock market bubble and one of the largest wealth divides in history with such feeble economic footing that the economy cannot even handle 1/4 of 1 percent increase in rates..
As I pointed out a few weeks ago the velocity of money is at an all time low for the simple reason that people are not spending money. As the vast majority of individuals are earning less today (in inflation adjusted numbers) than they were a decade ago and as the labor participation rate is at a 38 year low, it is no wonder that there is little to no economic benefits coming from more Fed stimulus. People act within their own personal constraints and the lower end of the labor market has not seen any economic recovery and is still struggling to recover from the last economic meltdown. Until they feel the benefit of an economic recovery throwing more stimulus at an overvalued stock market will not get the job done and raising rates will kill the supposed golden goose.
Had the Federal Reserve and the government spent their time and money looking at how to get the labor participation rate up rather than making fat Wall Street bankers fatter I would argue that the economy would be on solid footing. Simple examples to get money into the hands of the low earners would be to stimulate small business growth with tax incentives and lower reporting requirements, provide students with no interest on their student loans while sending a rebate check to those that just fell outside of this benefit and spend money on roads and infrastructure projects to name a few. Doing this would mean more jobs, resulting in more money in the hands of those that would spend the extra income, improving consumer confidence and an economy not reliant on zero interest rates. For now though their focus is on more stimulus and while their numbers seem to show success the global economy and company earnings are pointing in the opposite direction which is why my money stands on the sideline watching and waiting.
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