Wednesday, November 20, 2013 Hitchhiker's VUE

General Information and Analysis

I will attempt a few different things this morning.  I’ll provide some specific investment areas to try.  I will write and blog about portfolio allocation.  It will only be a start, as potentially it is a large area of academic research, and it is certainly controversial.

I’m not sure how to increase the number of people that follow my blog.  I certainly have not hit on the correct combination of materials, and so I will continue to cover currency daily. It is by following currency trends that I research other areas related to politics and its effects on economies. 

US

Summary of Yesterday’s Stock market and Start this Morning.

Yesterday a few big retailers reported earnings.  Basically, one would have a hard time interpreting what may happen this holiday season. The results were mixed. 

The market rallied to start, then gave way to late selling with the market recovering to nearly break even from the day before close.

The employment cost index (ECI) climbed in the third quarter.  The year-on-year rate, at plus 1.9 percent, has now been under 2 percent for 8 straight quarters.  The ECI is indicates wage trend, and is the easiest way to track wage inflation.  Wage pressures tend to rise when the economy is booming and demand for labor is rising. Businesses (like our small businesses) track the index to gain a sense of whether big businesses feel the need to raise prices based on wages.

Generally, inflation readings remain low.  There will be little pressure on the Federal Reserve to implement tapering.

The wage component is especially soft in the latest report, up only 0.3 percent for the lowest increase since just after the recession, in first quarter 2009. The year-on-year rate, at plus 1.6 percent, is the lowest since fourth-quarter 2011. The benefit component held up the composite in the latest quarter, jumping 0.7 percent for a 2.2 percent year-on-year rate.

The thing that jumps out is the very large 1.1 percent quarterly wage jump in management jobs tied to insurance.  That likely indicates what the effect of ObamaCare is:  Increased costs.

Here are other headlines:

·        JPMorgan admits to fraud in the mortgage-bond markets.  They have settled for $13B.  It did not explicitly admit wrongdoing. 

·        Bernanke:  Tapering depends on improvement in jobs data.  He also stated that inflation needs to rise to the Reserve’s target of 2%. 

·        Consumer Price Index was just released.  Estimates were for it to be 0, which is deflationary; not inflationary.  The actual number M/M was -.1%.  Monthly changes in the CPI represent the rate of inflation, but it is not the numbers that the Federal Reserve uses.  Tomorrow Producer Price Index will be released, and it is expected to be negative.  This is the ongoing tension between inflation and deflation, and even with all the stimulus, deflation is more than holding its own.

·        FOMC minutes will be released.

·        IMPORTANT: The information on Jefferson County in Alabama is often hidden in all the other news going on.  The good news is that Jefferson County successfully sold $1.8B in sewer warrants.  The bad news is the interest rate will be 6.85% which has a very long term maturity (40 years).  Jefferson County is in bankruptcy, and is the first municipality to successfully sell into the bond market.

·        IT experts (such as Oracle’s consulting) are recommending that HealthCare.gov be shut down due to security problems.  They are recommending a complete rebuild of ObamaCare systems.

·        Over night trading in the US indexes suggest an up opening.  Warning: historically the market will be very quiet and choppy before the FOMC minutes are released at 2:00 PM ET (11:00 AM PT). Then the race starts 2 minutes before.  Hint: You can tell if the minutes have been pre-released to banks by watching the price in the ½ building up to the release. 

·        Existing Home Sales are to be released at 10:00 AM ET.  The expectations are that sales will decline M/M.  Sales picked up when interest rates were down, but interest rates on mortgages began to climb, and house buying diminished over the last two months.  Mortgage rates have climbed from approximately 3.2% in December 2013 to the current rate of approximately 4.6%.    

Dollar Index

The dollar was up in Europe overnight.  However, after the retail sales reports were released this morning, the dollar index has turned negative.  At 5:30 (when retail was released) there was a large spike up, then a huge reversal down. 

 Retail Sales were relatively healthy, with autos leading the way.  Analysts are likely viewing this as that consumer confidence is increasing, and consumers will spend for the Holiday season.  

 However, CPI came in negative.  This might mean that traders (not investors) think that Yellen will increase QE, and that will be a drag on the dollar.  In turn we should see a spike in the stock market prices. And Walla Walla, Washington; Dollar down, Stock market up (big spike for this time of the morning). 

 The dollar should have been taken to the woodshed after Bernanke’s speech in Asia.  Basically he said 6.5% unemployment rate is NOT a trigger for rate hikes.  Interpretation: ZIRP is here for a very long time.  Not to worry, though, as Bernanke’s speech had almost no effect; as he is a lame duck.

 Evans (a voting member of FOMC) said yesterday that Fed Bond purchases may have to be increased by 50% in 2014.  That increased the pressure and greased the slippery slope for devaluing the dollar in the FOREX markets.

Canada

Eurozone

Australia

China

Japan

Do you remember when Japan always had a trade surplus?  Those days are bygones.  Japan printed another trade deficit and it was larger than expected. 

Japan remains an excellent on-going case study.  It is excellent if we want to study free-markets in the global economy vs. central planned reaction to a downturn; a downturn because (in my opinion) of their number 1 competitor: China, rising production prices, and aging demographics.

Overall, the Japanese people seem to overwhelmingly feel Abenomics is working.  However, what appears to be missing in action is his promise to make fundamental reforms to the labor market.  Now, as every politician turned reformer will tell us, confrontation with labor is hard.   It is particularly difficult in Japan, as consensus is highly valued.  Challenging vested interests, however, means confrontation with labor and others. 

The Bank of Japan is aiming to create 2% inflation through de-valuing the Yen.  Since they started this policy six months ago, how is that program fairing in Japan’s Financial Markets and currency in FOREX?

I funny thing happens on the way to the market when Japan tries to make the YEN less expensive. 

Wages do not go up, heralding inflation, but imported fuel and other imports become more expensive because of the weak yen. Being an import dependant economy, this trend bodes ill for Japan’s public living standards.  Price is going up and wages are stagnant or going down.  (Does this sound familiar to the people in the US?)

Here is one link to provide an overview: http://www.japantimes.co.jp/news/2013/11/17/national/bojs-money-mountain-growing-but-debt-may-explode/#.UozJ7sSsh8G

“There is no demand for funds on the part of businesses. That’s why the monetary easing is not working,” Noguchi said.

The year-on-year increase rate of Japan’s monetary base — the sum of cash in circulation plus banks’ current account balances at the BOJ — surged from 23.1 percent in April to 45.8 percent in October, thanks to the BOJ’s aggressive operations.

But that of Japan’s money stock — the total amount of monetary assets available in an economy including credit created by bank loans, but excluding deposits held by financial institutions and the central government — only rose to 3.3 percent from 2.3 percent in the period.

This means banks are just depositing the massive funds provided by the BOJ in their own accounts at the central bank. The unloaned cash is thus having little affect on the real economy.”

Actually, there seems to be a misunderstanding or error.  Banks get the money which provides liquidity for only 2 purposes: 1. Interbank lending –where banks holding cash assets in excess of lawful reserve requirements lend reserves to banks that are short of required reserves 2. Pay out cash to customers who wish to draw down their demand deposits in the form of cash.  For point #1, money just moves between banks, and it never reaches the customer.  #2 reserves of the bank are reduced, but currency in circulation will increase to exactly the same extend.  Both leave the liabilities on the Central Bank balance sheet unchanged.  The money supply is left unchanged as well. 

In a general way, all Central Banks (USA, UK, Canada, Eurozone) all have this problem.  The main goal of buying debt as they are doing is to suppress long term interest rates.  In Japan, banks are not lending, and the money supply is actually regressing. 

The only reason Japan’s money supply is growing is because the BOJ occasionally buys assets from non-banks. 

If the banks cannot lend out their reserves directly, what can they do?  Well BOJ and the Federal Reserve both want to drive interest rates down, while creating manageable inflation.  Inflation is created, then when money is created. 

“Big money” (meaning lots of it) is created through credit expansion.  (Ah, I wish I could teach the young ones about fiat money, debt and how this works.)  Banks can literally create money out of thin air by “crediting” accounts. 

If you read this far, and want to know how this happens, leave a comment.  I will provide the rest-of-the story.

Suffice it to say, that so far under Abenomics (and for the last 2 decades) Japan is failing to stimulate the economy. 

Japan may be showing the USA that when policy rates have effectively fallen to zero, monetary policy no longer works.  In Japan, the economy’s potential for grown has declined, and monetary measures cannot solve that problem.  There is a limit to what monetary policy can do.