The Good Old Days

"Wish we could turn back time to the good old days;
When our momma sang us to sleep but now we're stressed out." - lyrics to the song Stressed Out by Twenty One Pilots

I know I have been off the air for a month but it is summer and time for a break right?  In all honesty while it was partially a break, the lack of correspondence was more a factor of too much work on my plate so something had to give and I chose to let the blog go for a month.  That said not a lot has changed in the last month; more hot air from the central bankers of the world, more stimulus and a couple of very poor candidates to chose from to run the country.

I was reminiscing over the last few weeks about what life used to be like in the "good old days".  It is hard to even remember a time before 1995 in the investment world but it seems that with the advent of the Internet everything changed.  To me those were the good old days when central bankers of the world operated in a relatively insulated bubble, focusing on their local economies.  Stimulus was left to tinkering with interest rates and bank reserves with limited open market manipulation.  Recessions came and went as a normal course of business.  Companies were valued on their balance sheet strength, growth opportunities and profitability.  Global debt (businesses, consumers and government) according to The McKinsey Global Institute stood at around $30 Trillion.

Fast forward to today and global debt is north of $200 Trillion or roughly $27,000 per person!  Furthermore the central bankers of the world have decided that $130 Trillion in 20 years is not even close to enough so they are pushing even more debt out into the market.  Just this month the BOE, Bank of Japan and the ECB have announced additional stimulus amounting to more than $50 billion a month!  What are we supposed to do with all this additional debt?

The idea is that we spend it on useless things like another iPhone or a new car (both of which are direct direct beneficiaries) however all that this stimulus does is bring future sales forward stealing economic growth from the future.  An example is China who reduced the tax on automobile purchases to 5% from 10%.  This stimulus increased automobile sales in China to north of 26 million units in the quarter but this incredible run will surely end when the stimulus ends at the end of the year.  People do not need new cars every year and looking forward the result of the stimulus will be to destroy automobile sales in China next year.

The issue is that adding more debt is not helping but is crowing out the normal private market and economic growth.  This crowding out is cutting heavily into GDP growth rates but is shown in its stark reality when you look at Wall Street.  In 1998 when "stimulus" had just begun under Greenspan, the number of companies publicly traded peaked at just over 8,000.  Since then the effect of all of this debt has been to crowd out the public markets and the number of listed companies is now half of what it was.  Some of this has to do with poor management however the bulk of the change has been from companies using debt to acquire other listed companies or management teams taking companies private using debt as the lever.

Not only have companies been using debt to acquire each other, they have also been turning to debt to juice their poor results.  Issue debt, buy back shares and hey presto you have better than expected earnings per share!  In fact companies are so awash with debt that some of them have massive negative tangible book values.  Remember that tangible is something that is real like a desk or a car whereas intangible is imaginary like Goodwill.  In the case of IBM as an example removing $42 billion of goodwill and intangible assets results in a negative book value of $25 billion!  Broadcom is not much better with a negative tangible book value of $22 billion.  Who would ever buy these shares and why are they even listed?

Looking at the balance sheets of some big names it just amazes me that more attention is not given to the balance sheets of businesses.  Microsoft now has $55 billion where not too long ago it had zero, Oracle has $43 billion, Apple has $85 billion, Intel $24 billion, IBM $44 billion and Cisco is at $29 billion.  Now while these companies are large this debt burden is enormous.  Heaven help them if at some point int he future interest rates rise and they cannot repay the debt!

But while interest rates are low the party continues and my analysis points to low interest rates for a while to come.  Not that I think that interest rates should be low, they should not, but because the central bankers of the world are going to continue to manipulate them for as long as possible.  They will also continue to print money in a vein hope that one of these dollars will eventually stimulate the global economy.  How ignorant and blind are they?  This is the biggest experiment known to man and one that has no chance of working out well.  The problem is that while ALL of the central bankers of the world continue to push money into the pot together there are no real repercussions.  Everyone's interest rates remain low or continue lower and everyone's currency weakens at the same rate.  No-one gains the upper hand so they try even more "stimulus".  Bond yields continue to wilt and it is just a matter of time before helicopter money policies are used (by passing the banking system and sending money directly to people).  Already there is talk of a perpetual bond (one with no end) and other crazy schemes but the results are all the same - nothing but a large pool of debt!

In this world of unbelievable craziness comes the demand for social policies and walls from the electorate.  Voters are turning to politicians who are promising things that are not only detrimental to long term growth but to the viability of capitalism.  It will not be long before capitalism is pointed to as the root of the problem.  However, it is not capitalism that is creating the problem it is the manipulation of the very fabric of free markets, the heart of capitalism, by the central bankers of the world, the supposed protectors of capitalism, that is at fault.

So while it is impossible to bring back the good old days it is possible to protect yourself and your portfolio by extracting yourself from debt and moving into gold or other assets that are antifragile.

There's Gold in Them There BREXITs!

Yesterday Britain voted to exit the European Union the so called BREXIT.  As expected the decision was close but the result was unexpected and threw global markets into a frenzy.  The European markets took the brunt of the selloff with Germany down more than 8%.  US markets reacted in less of a panicked fashion but were still off more than 3% at opening.  The initial knee jerk reaction will probably be muted in the short run as the actual exit will take a number of years to effect and it remains unknown as to what sort of impact this will really have on the UK and the rest of the European Union.  Certainly the press and the economists of the world are having a field day predicting a catastrophe but as we all know these predictions are more often than not vastly exaggerated.

I for one am not even going to try (in this blog at least) predict the long term fall out of this decision but there is a chance that other European countries try to exit as well causing the downfall of the EU.  This may well happen but the main question is whether the core group of nations remain and I believe that there are sufficient benefits for the 6 largest economies to remain unified regardless of whether smaller outlier countries exit (not that the UK is a small economy but the UK has sat on the fence of the EU since it was created so the result of an exit should be less impactful than one of the core group of nations exiting).   So while the markets of the world gyrate wildly to the unexpected news it is my thought that in the long run the overall impact will be muted.

That said the vote exposed just how annoyed the world is with their various political bodies.  Not only did the UK snub their noses at the incumbent party leading to the resignation of the Prime Minister, but now there is renewed talk of Scotland leaving Britain.  The United States is no different in that Trump has achieved a level of success that few believed would be possible without a population that is resentful of their leaders.  With the vast majority of Americans feeling that their politicians are out of touch with their plight plus the increasing divide between the have and the have nots it is clear that a change is inevitable.  It is just a shame that this desire for change was not directed towards a candidate with real leadership qualities that could infect rational change rather than a crass bully but unfortunately the desperation has been misdirected.

The other thing that should be clear is that precious metals and particularly gold are a hedge against the current malaise of the world.  Gold spiked more than $70 an ounce after the BREXIT was announced.  As opposed to the collapse of the global markets gold rallied more than 6%!  Gold stocks also went into orbit with some names up more than 10%.  It is amusing to me to listen to gold haters argue about what a poor investment gold is when during times of crisis it has repeatedly proven its worth as a hedge against disaster.  If you believe, as I do, that the world is clearly on the wrong path then owning gold, gold stocks or gold ETFs is a must.  Even if you hate the idea of owning gold today should be a signal that gold will provide downside protection for your highly overvalued stock portfolio.

So take note and realize that there’s gold in these BREXITs and other global catastrophes particularly when you have the world’s central bankers determined to destroy any kind of fiat money value.  Take this as a warning and position yourself accordingly.

A Recipe for Stagnation

"Agitate! Agitate! Ought to be the motto of every reformer.  Agitation is the opposite of stagnation - the one is life, the other is death." - Ernestine Rose

As has been widely broadcast the minimum wages across the country are heading higher.  It seems like the States are in a race to see who can force minimum wage to $15 an hour in the shortest amount of time.  The theory is that if you can move minimum wages higher, the people at the bottom of the wage scale will be moved to a position of financial strength improving their spending power and benefiting all.  Politicians look at it as a transfer of wealth from those that can afford it to those that need it most.  On paper this seems to make sense but digging a little deeper and it is clear that this is another government intervention that will have unintended consequences.

I certainly understand the political agenda behind raising the minimum wage.  I also understand that without some form of government  intervention wages at the lower end of the spectrum would stagnate forever.  That said the problems with the most recent round of forced increases are the timing and the rapid acceleration of the base wage. 

First let's look at the timing of the wage increase.  Were the economy booming companies would be competing for workers and the natural order of business would result in pay rates rising to attract workers.  Currently the economy is on such weak footing that the Reserve Bank is hesitant to raise interest rates even a 1/4% higher.  Furthermore as long term readers of this blog will know, while the unemployment rate is relatively strong, the labor participation rate and the U6 unemployment rate is pointing to anything but strength.  Had the politicians waited for economic strength the market would have been resilient enough to handle the increases however this is not the case today.

The second issue is that the wage rates will increase pretty much every year through 2020 by which time most if not all States will have a minimum wage of $15 an hour.  This rapid acceleration will impact earnings significantly and will be a factor that needs to be considered before starting any new business or expanding into new areas.  This will slow down hiring and make companies reduce expansion affecting job creation.  Furthermore the wage increases are not limited to minimum wage earners but has been extended to lower management as well. 

By the end of the year salaried employees earning less than $48,000 a year will be required to be paid overtime.  This impact will be the largest of all as companies will scramble to reduce these key employees' hours or remove the position completely by consolidating the position into one higher paying position.  It will also impact the upwardly mobile as these go getter's will have to reduce the hours worked thereby negating their advancement opportunities as they will not be able to showcase their can do attitudes without costing the company money. 

The biggest impact of these new policies though is that this is yet another barrier to entry for small and start up companies.  To these companies a high level of pay would be $40,000 a year and that would equate to a senior manager.  Making this position cost more is akin to putting a bullet in the heart of small business and business start ups.  As you would have read in last week's blog there is already a major slow down in net company formations and this slowdown is one of the largest causes of anemic GDP growth.  Raising the cost to starting a company even further will have a massively negative impact on small company start ups which will kill any idea of GDP expansion. 

The results of all of this is that the economy will stagnate.  GDP growth will be anemic until such time as all of these wage increases can be factored into the price of goods and services and given the weakness of the global economy this will take a long time.  In the meantime during this adjustment period the divide between those that have and those that do not will widen even further in complete contrast to the desired impact.  This new law has effectively placed another golden spoon in the hands of large business at the expense of the job and GDP growth engine, small business; their moat is even more secure and this is a huge problem if you want to see GDP accelerate.  Better get used to the stink of stagnation!

Two out of Three Ain't Bad?

"And all I can do is keep on telling you, I want you, I need you; But there ain't no way I'm ever going to love you; Now don't be sad, 'cause two out of three ain't bad" - Lyrics to the song Two Out of Three Ain't Bad by Meatloaf

If there is one metric that tells the true story of the state of the economy it is the labor statistics.  Or does it?  As I have repeated in previous blogs, pretty much every statistic from inflation to the labor market numbers are fudges, guesses, estimates stabs in the dark; call them what you will but they are manipulated and the labor statistics are no different.

As an example take the monthly labor reports.  Each month the Bureau of Labor Statistics adds a fake 75,000 jobs to the labor force from their Birth/Death computer model to account for new company births.  This is based on the range of new company start ups from the previous 20 years prior to the financial crisis.  During this period on average the net number of new firms (that means more firms opening than closing per year) ranged between 75,000 and 200,000 a year.  To account for this the BLS blindly adds 75,000 new jobs per month to their reported numbers.  Well according to the US Census Bureau the number of net new company openings since the financial crisis is just 33,000 a year, less than half of the prior period so this fake number of new jobs is vastly overstated.

Even though we know the numbers are wrong they do tell a story.  If they are consistently wrong each month then at least we have a benchmark to work with.  Taking this benchmark as being overly optimistic (based on the above analysis) means that the printed numbers are far worse than what is published.  To offset some of the errors adjustments are made to reflect miscalculations and these result in revised numbers that are possibly closer to the true number however most people ignore the revisions but their story tells a clearer tale.

Therefore taking today's published May job figures (prior to revisions) of non farm payroll increasing by 38,000 and private sector payroll increasing by 25,000 regardless of the how wrong they are they are still anemic.  Consensus was for them each to increase by 160,000 so these are truly disastrous figures.  On top of this April and March's numbers were revised downwards even further to fall well below the 160,000.  This 160,000 number is Wall Street's current "required" number to show economic health.  This number has also been revised lower as the economy was sputtering so badly that they had to reduce the number in order to print bullish headlines.  Were the economy truly healthy this "required" number would be in the range of 250,000 a month but as that is not even remotely possible, Wall Street analysts have quickly reduced their number of economic stability.

The next interesting statistic comes from the unemployment rate which fell to 4.7% versus 5.0% in April.  Wow, so magically the unemployment rate is falling even as less firms are added to the pool of companies AND as hiring falters.  In an economy the size of the United States you need to increase the number of jobs by roughly 150,000 a month just to remain at status quo in terms of the unemployment rate.  The reason for this is that the population is growing so the economy needs to suck up the additions to the work force to maintain equilibrium but magically the unemployment rate is falling.  How is this even possible?

Well when a person goes on unemployment benefits they are logged as unemployed.  As long as they remain on benefits they are counted.  If their benefits run out before they can find a job then they are magically "employed" according to the count!  This is how the number is improving.  Taking a look at the U6 number which includes people working part time but want full time work the number quickly balloons to 9.7%.  This number is stuck at roughly the same level as where it ballooned to during the 2002 and 2003 recession; hardly something to sing about.

The most telling number of all to me is the participation rate.  This number basically takes the total number of people working divided by the number of people in the population (not quite as simple as that but you get the idea) and this results in another metric.  This number FELL to 62.6% from 62.8% and is well BELOW where it was at the height of the recession!  Yes back in 2009 this number was around 65% so 5 trillion dollars of money has managed to make this number worse by almost 4%!  And to think that they are actually considering an interest rate hike because the economy is "strengthening"; what a joke.  I guess the rate hike is based on the lyrics of the song that, "two out of three (employed) ain't bad'!

Upwardly Mobile

"It is good to follow one's own bent, so long as it leads upward." - Andre Gide

One of the bedrocks of economic theory is that labor will migrate towards areas where there are higher wages and a better quality of life.  The theory goes that if you remove all borders then workers will naturally flow to areas flush with job opportunities.  This is one of the reasons behind creating the Euro Zone or the North American Free Trade Agreement.  Furthermore there is proof that children who are moved to areas with better education, lower crime and where there is a preponderance of two parent families earn more than 10% than their peers.  With this as proof one would think that the theory would hold as what parent doesn't want the best for their children?

A new study however has shown that the theory may not hold true specifically for those reliant on government subsidies.  Unfortunately these are the people that would benefit most from an improvement in living standards and are the demographic of people that are assumed most likely to move with their relevant industries.  The finding is that not only can these people often not afford the expense to move but they are tied to their subsidies.  If they move they lose their subsidies such as housing and food stamps which is often their major source of financial sustenance.

Now moving from one town does not mean that the subsidies are lost forever but it often means that they are lost for a period of time.  This period of time is more than most are able to handle and so they stay put.  Changing the way that the subsidies are issued would be a big step in the right direction however society has found many ways of blocking the needy from entering the upper class halls.  One is to restrict low income housing or change the building specifications to effectively stop the building of any space that would allow cheap units to be rented.

In addition to these issues America has long had a love of the automobile.  This love has created a system where moving large bodies of people around the country is expensive and time consuming.  Public transportation while improving is still far behind Europe and most of the rest of the modern world so spending money on these infrastructure projects would not only create work for those needing it but would bolster the economy far more than throwing more money at banks.

Creating a truly mobile work force should be a priority in the United States.  Spreading the burden of subsidies evenly would assist those cities that are struggling to handle the draws and creating mobility would give everyone the ability to find work at a decent wage.  The result would be a truly upwardly mobile economy and one that would worth celebrating and investing.

Measuring GDP

"Not everything that counts can be counted and not everything that can be counted counts." - Albert Einstein

The above quote is so true but humans have a natural tendency to try to place a value on pretty much everything.  When it come to the world of economics, counting is a virtual impossibility because in most instances the things being counted are so vast and changing so regularly (if not every millisecond) that even after time and effort is made to calculate the number it is guaranteed to be wrong!  The thought in economics is that even though it is well known that the number is incorrect it is better than no number at all.

There is no number more relied on and more wrong than GDP.  The estimate of changes in GDP is used to assess whether the economy is growing too slowly or too fast (or not at all) and to gauge whether inflation is rampant, in line with targets or deflationary.  It is used to determine whether we are in an overheated booming economy or a stagnant spluttering economic recession.  Central bankers rely on it to create their strategies for stimulating or cooling down the economy and governments are held to account, particularly at election time, for the their ability to provide good GDP growth.  Currencies swing higher and lower reflecting the strength or weakness of the underlying economy's GDP growth in comparison to everyone else, and interest rates depend to a large extent on the outlook for GDP growth or lack thereof.  To say it is an important number is an understatement however to calculate it is all but impossible.

Created in the 1930s GDP was initially relatively simple to calculate.  Take a basket of goods and services and then revalue them a year later and there's your answer/  Economies in those times were based more on manufacturing and farming than it was on services so computing the change in the inputs was relatively simple.  Fast forward to today and the complexities of the modern world make a mockery of the number.  Examples abound but I will mention only a few:

1. The smart phone in your pocket has more computing power than a PC had in the 90s and the price is lower so is that deflationary or should there be an adjustment for improved productivity?
2. The new smart phone is more pricey than last year's version but it comes with a number of new features so is this inflationary or should the price be adjusted lower so that it incorporates the technological advances that make your life easier?
3. What about the use of your car to take passengers for a paid ride (Uber) or that extra room in your house that is rented to travelers (AriBnB) or all the free entertainment that is available on YouTube or Facebook?  How should this be included in GDP?
4. What about the billions of dollars that are flowing through the black markets of the world?

The case for the basket of goods capturing a change in GDP is so rife with problems that it is starting to make the number of little relevance.  When you start to consider the inflationary aspects of the number and the adjustments that are made for technological advances it becomes even more haphazard.  How can you compare the change in price of say a fax machine and the use of email or crutches with prosthetics or vinyl records with streaming digital music?

The issues are so complex that whatever number is calculated it is far from reality.  This is why everyone should calculate their own inflation rate particularly when it comes to determining a real rate of return on your investment.  Without it you cannot get a clear indication of real portfolio returns and this will have a tremendous impact on your retirement planning.  But for all its problems having a number is better than having no number at all but basing your financial future on this number is akin to failure.  Use it as a loose gauge of economic activity and follow any large swings but do not hang your hat on this number.

Desperado

"Desperado, why don't you come to your senses, you've been out riding fences for so long now;
Oh your a hard one, I know that you've got your reasons, these things that are pleasing you will hurt you somehow>" - Lyrics to a song by The Eagles

Is it just me or is the world filled with a lot of Deperados?  The central bankers of the world are desperately doing their best to convince the world that more debt is the solution to our problems and are considering more desperate measures to pump more useless money into a flagging economy in a desperate attempt to stave off the inevitable.  The general population is not convinced and is showing its frustrations at the polls by desperately buying in to the rhetorical garbage that is coming from the mouths of the Presidential candidates.  Not only will the policies of either candidate not solve the man in the streets woes, but some of them will create a far larger mess but we will see who takes over in November and deal with that then.

Through all of this the stock market continues to toy with new highs but has yet to print any for over a year and we are now into the May to October low volume trading period so anything can happen.  To me it is truly amazing that the stock market is up at all for the year; corporate sales and earnings are continuing to decline (GAAP earnings were down 15% in 2015 and were down another 8% year over year in Q1 for  the S&P 500), two thirds of the companies reporting earnings cut guidance for the second quarter, GDP growth in the first quarter was only 0.5% and business investment in Q1 was the lowest since the 2009 recession.

With all of these negative data points plus rising oil prices and poor economic activity being reported across the globe I firmly believe that we are entering the end game in terms of the stock market.  As I have mentioned repeatedly though the Federal Reserve will come to its rescue with more support in the form of rate cuts (possibly going negative to join the global party) and money stimulus.  The issue is that the impact of further rate cuts and monetary stimulus will be muted and the results of trillions of dollars of stimulus is weak economic growth and a faltering labor market.  The next step will more than likely be the "helicopter" method coined by Ben Bernanke.  The idea is to go around the banks and directly to the consumer by throwing money out the side of a helicopter!  Sounds like a great and well thought out plan like the rest of the central bank's policies!

All of these desperate attempts at stimulus are not providing the economic windfall that was predicted and more stimulus will not magically create jobs or increase productivity.  In fact productivity has continued to lag as the burden of debt is creating an economic drag that has crowded out the private sector (and more importantly the small business and middle class) resulting in continued lackluster growth and fractions within political parties.  Adding more debt will not magically solve these issues but will create a larger problem.  In this highly volatile environment if you are not posturing yourself for the inevitable then you are opening yourself up to enormous risk.  My advice is to look to gold stocks and alternative investments or go to cash but either way exit as soon as possible.