tag:blogger.com,1999:blog-74753952706319490542024-03-13T03:15:35.488-07:00Capitalism and Freedom“The reality is that unconventional monetary policy is difficult, perceived as risky, and never pursued with the vigor of conventional monetary policy.”
--Paul Krugman, NYT, March 17, 2010
"Reducing policy interest rates to the zero bound fails to stimulate credit supply and demand in a ‘balance sheet recession’ in which the private sector is deleveraging."
--Adair Turner, 20 May, 2013
Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.comBlogger440125tag:blogger.com,1999:blog-7475395270631949054.post-72885891234892871392020-10-02T08:58:00.004-07:002020-10-02T08:58:29.168-07:00Some Free Cashflow Aristocrats<p> <span style="font-family: "Times New Roman"; font-size: 18pt; white-space: pre-wrap;">The intended purpose of corporate financial reporting is to enable </span></p><p><span style="font-family: "Times New Roman"; font-size: 18pt; white-space: pre-wrap;">investors to make informed decisions concerning securities selection. </span></p><span id="docs-internal-guid-2f407ddc-7fff-050f-f83b-953d8e952d1d"><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">But many investors and equity analysts there is much too much emphasis on reported and forecast GAAP earnings. The fact is that under GAAP a company can report positive earnings despite negative free-cashflow (FCF). Good examples are Enron, WorldCom and, today, Netflix. </span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">Dividends and buybacks are funded by FCF, not GAAP earnings. GAAP earnings are pretty much useless in terms of actionable information content.</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">I focus on FCF, and my preferred ratio is FCF divided by market capitalization (FCF/MK) or, if you prefer, FCF per share divided by the share price. For many companies FCF can be volatile due to the bumpiness of capex such that one should use more than one year’s FCF to determine sustainability (and growth rate). </span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">I periodicallytroll through Morningstar’s financial data on the lookout for companies meeting the following criteria:</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">Large cap</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">Nonfinancial </span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">High and reasonably stable (or growing) FCF/MK</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">Using these criteria I have identified the following names. Below are the tickers and the company’s recent FCF/MK rounded to the nearest %):</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">MO 14%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">WBA 14%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">IBM 11%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">INTC 10%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">BX 9%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">T 9%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">CSCO 9%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">TGT 8%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">UNH 7%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">PM 7%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">EMR 7%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">Before buying one of these I suggest:</span></p><ol style="margin-bottom: 0px; margin-top: 0px;"><li dir="ltr" style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; list-style-type: decimal; vertical-align: baseline; white-space: pre;"><p dir="ltr" role="presentation" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">Look at FCF volatility and growth rate;</span></p></li><li dir="ltr" style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; list-style-type: decimal; vertical-align: baseline; white-space: pre;"><p dir="ltr" role="presentation" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">Have some understanding of the company’s business model (sustainability of FCF);</span></p></li><li dir="ltr" style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; list-style-type: decimal; vertical-align: baseline; white-space: pre;"><p dir="ltr" role="presentation" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">Look for a non-capital-intensive business model;</span></p></li><li dir="ltr" style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; list-style-type: decimal; vertical-align: baseline; white-space: pre;"><p dir="ltr" role="presentation" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">Compare FCF to both assets and debt.</span></p></li></ol><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">For comparison purposes, here is the data for the FAANG names which appear to be mediocre by FCF criteria (and, in the case of NFLX, radioactive).</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">FB 3%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">AAPL: 4%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">AMZN: 2%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">NFLX: --</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">GOOG: 3%</span></p><p dir="ltr" style="line-height: 1.7999999999999998; margin-bottom: 0pt; margin-top: 0pt;"><span style="font-family: "Times New Roman"; font-size: 18pt; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; vertical-align: baseline; white-space: pre-wrap;">The FCF/MK ratio does not measure long-term growth prospects which are to some extent conjectural and require much more in-depth analysis. </span></p><br /><br /></span>Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com5tag:blogger.com,1999:blog-7475395270631949054.post-33128598817217703162018-03-06T16:01:00.001-08:002018-03-06T16:01:00.337-08:00Hackers Linked to China’s Army Seen From EU to D.C.<b id="docs-internal-guid-371eb40f-fdc1-5fef-92fc-16b9581c3ea3" style="font-weight: normal;"><br /></b>
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<span style="-webkit-text-decoration-skip: none; background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration-skip-ink: none; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Hackers Linked to China’s Army Seen From EU to D.C.</span></h1>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Bloomberg</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">By Michael Riley and Dune Lawrence - Jul 26, 2012</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The hackers clocked in at precisely 9:23 a.m. Brussels time on July 18 last year, and set to their task. In just 14 minutes of quick keyboard work, they scooped up the e-mails of the president of the </span><a href="http://www.consilium.europa.eu/homepage" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">European Union Council</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">, </span><a href="http://topics.bloomberg.com/herman-van-rompuy/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Herman Van Rompuy</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">, Europe’s point man for shepherding the delicate politics of the bailout for Greece, according to a computer record of the hackers’ activity.</span></div>
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<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Over 10 days last July, the hackers returned to the council’s computers four times, accessing the internal communications of 11 of the EU’s economic, security and foreign affairs officials. The breach, unreported until now, potentially gave the intruders an unvarnished view of the financial crisis gripping Europe.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">And the spies were themselves being watched. Working together in secret, some 30 North American private security researchers were tracking one of the biggest and busiest hacking groups in China.</span></div>
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<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Observed for years by U.S. intelligence, which dubbed it Byzantine Candor, the team of hackers also is known in security circles as the Comment group for its trademark of infiltrating computers using hidden webpage computer code known as “comments.”</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">During almost two months of monitoring last year, the researchers say they were struck by the sheer scale of the hackers’ work as data bled from one victim after the next: from oilfield services leader </span><a href="http://www.bloomberg.com/quote/HAL:US" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Halliburton Co. (HAL)</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;"> to Washington law firm Wiley Rein LLP; from a Canadian magistrate involved in a sensitive China extradition case to Kolkata-based tobacco and technology conglomerate </span><a href="http://www.bloomberg.com/quote/ITC:IN" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">ITC Ltd. </span></a></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Gathering Secrets</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The researchers identified 20 victims in all -- many of them organizations with secrets that could give China an edge as it strives to become the world’s largest economy. The targets included lawyers pursuing trade claims against the country’s exporters and an energy company preparing to drill in waters China claims as its own.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">“What the general public hears about -- stolen credit card numbers, somebody hacked </span><a href="http://www.bloomberg.com/quote/LNKD:US" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">LinkedIn (LNKD)</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;"> -- that’s the tip of the iceberg, the unclassified stuff,” said Shawn Henry, former executive assistant director of the </span><a href="http://www.fbi.gov/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">FBI</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;"> in charge of the agency’s cyber division until leaving earlier this year. “I’ve been circling the iceberg in a submarine. This is the biggest vacuuming up of U.S. proprietary data that we’ve ever seen. It’s a machine.”</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Exploiting a hole in the hackers’ security, the researchers created a digital diary, logging the intruders’ every move as they crept into networks, shut off anti-virus systems, camouflaged themselves as system administrators and covered their tracks, making them almost immune to detection by their victims.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Every Move</span></h2>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The minute-by-minute accounts spin a never-before told story of the workaday routines and relentless onslaught of a group so successful that a cyber unit within the </span><a href="http://www.osi.andrews.af.mil/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Air Force’s Office of Special Investigations</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;"> in San Antonio is dedicated to tracking it, according to a person familiar with the unit.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Those logs -- a record of the hackers’ commands to their victims’ computers -- also reveal the highly organized effort behind a group that more than any other is believed to be at the spear point of China’s vast hacking industry. Byzantine Candor is linked to China’s military, the </span><a href="http://topics.bloomberg.com/people%27s-liberation-army/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">People’s Liberation Army</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">, according to a 2008 diplomatic cable released by WikiLeaks. Two former intelligence officials verified the substance of the document.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Hackers and Spies</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The methods behind China’s looting of technology and data - - and most of the victims -- have remained for more than a decade in the murky world of hackers and spies, fully known in the U.S. only to a small community of investigators with classified clearances.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">“Until we can have this conversation in a transparent way, we are going to be hard pressed to solve the problem,” said Amit Yoran, former National Cyber Security Division director at the Department of </span><a href="http://topics.bloomberg.com/homeland-security/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Homeland Security</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Yoran now works for RSA Security Inc., a Bedford, Massachusetts-based security company which was hacked by Chinese teams last year. “I’m just not sure America is ready for that,” he said.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">What started as assaults on military and defense contractors has widened into a rash of attacks from which no corporate entity is safe, say U.S. intelligence officials, who are raising the alarm in increasingly dire terms.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">In an essay in the Wall Street Journal July 19, President </span><a href="http://topics.bloomberg.com/barack-obama/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Barack Obama</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;"> warned that “the cyber threat to our nation is one of the most serious economic and national security challenges we face.” Ten days earlier, in a speech given in Washington, National Security Agency director Keith Alexander said cyber espionage constitutes “the greatest transfer of wealth in history,” and cited a figure of $1 trillion spent globally every year by companies trying to protect themselves.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Harvesting Secrets</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The networks of major </span><a href="http://topics.bloomberg.com/oil-companies/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">oil companies</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;"> have been harvested for seismic maps charting oil reserves; patent law firms for their clients’ trade secrets; and investment banks for market analysis that might impact the global ventures of state-owned companies, according to computer security experts who asked not to be named and declined to give more details.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">China’s foreign ministry in Beijing has previously dismissed allegations of state-sponsored cyberspying as baseless and said the government would crack down if incidents came to light. Contacted for this story, it did so again, referring to earlier ministry statements.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Private researchers have identified 10 to 20 Chinese hacking groups but said they vary significantly in activity and size, according to government investigators and security firms.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Group Apart</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">What sets the Comment group apart is the frenetic pace of its operations. The attacks documented last summer represent a fragment of the Comment group’s conquests, which stretch back at least to 2002, according to incident reports and interviews with investigators. Milpitas, California-based FireEye Inc. alone has tracked hundreds of victims in the last three years and estimates the group has hacked more than 1,000 organizations, said Alex Lanstein, a senior security researcher.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Stolen information is flowing out of the networks of law firms, investment banks, oil companies, drug makers, and high technology manufacturers in such significant quantities that intelligence officials now say it could cause long-term harm to U.S. and European economies.</span></div>
<h2 dir="ltr" style="line-height: 1.38; margin-bottom: 4pt; margin-top: 18pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">’Earthquake Is Coming’</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">“The activity we’re seeing now is the tremor, but the earthquake is coming,” said Ray Mislock, who before retiring in September was chief security officer for DuPont Co., which has been hacked by unidentified Chinese teams at least twice since 2009.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">“A successful company can’t sustain a long-term loss of knowledge that creates economic power,” he said.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Even those offline aren’t safe. Y.C. Deveshwar, 65, a businessman who heads ITC, India’s largest maker of cigarettes, doesn’t use a computer. The Comment hackers last year still managed to steal a trove of his documents, navigating the conglomerate’s huge network to pinpoint the machine used by Deveshwar’s personal assistant.</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">On July 5, 2011, the thieves accessed a list of documents that included Deveshwar’s family addresses, tax filings, and meeting minutes, as well as letters to fellow executives, such as London-based </span><a href="http://www.bloomberg.com/quote/BATS:LN" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">British American Tobacco Plc (BATS)</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;"> chairman Richard Burrows and BAT chief executive, Nicandro Durante, according to the logs. They tried to open one entitled “YCD LETTERS” but couldn’t, so the hackers set up a program to steal a password the next time his assistant signed on.</span></div>
<h2 dir="ltr" style="line-height: 1.38; margin-bottom: 4pt; margin-top: 18pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Keeping Quiet</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">When Bloomberg contacted the company in May, spokesman Nazeeb Arif said ITC was unaware of the breach, potentially giving the hackers unimpeded access to ITC’s network for more than a year. Deveshwar said in a statement that “no classified company related documents” were kept on the computer.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Companies that discover their networks have been commandeered usually keep quiet, leaving the public, shareholders and clients unaware of the magnitude of the problem. Of the 10 Comment group victims reached by Bloomberg, those who learned of the hacks chose not to disclose them publicly, and three said they were unaware they’d been hacked until contacted for this story.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">This account of the Comment group is based on the researchers’ logs, as well as interviews with current and former intelligence officials, victims, and more than a dozen U.S. cybersecurity experts, many of whom track the group independently.</span></div>
<h2 dir="ltr" style="line-height: 1.38; margin-bottom: 4pt; margin-top: 18pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Private Investigators</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The researcher who provided the computer logs asked not to be named because of the sensitivity of the data, which included the name of victims. He was part of a collaborative drawn from 20 organizations that included people from private security companies, a university, internet service providers and companies that have been targeted, including a defense contractor and a pharmaceutical firm. The group included some of the top experts in the field, with experience investigating cyberspying against the U.S. government, major corporations and high profile political targets, including the </span><a href="http://topics.bloomberg.com/dalai-lama/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Dalai Lama</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Like similar, ad hoc teams formed temporarily to study hackers’ techniques, the group worked in secret because of the sensitivities of the investigation aimed at state-sponsored espionage. A smaller version of the group is continuing its research.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">As the surge in attacks on businesses and non-government groups over the last five years has pulled private security experts into the hacker hunt, they say they’re gradually catching up with U.S. counterintelligence agencies, which have been tackling the problem for a decade.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Espionage Tools</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">One Comment group trademark involves hijacking unassuming public websites to send commands to victim computers, turning mom-and-pop sites into tools of foreign espionage, but also allowing the group to be monitored if those websites can be found, according to security experts. Sites it has commandeered include one for a teacher at a south Texas high school with the website motto “Computers Rock!” and another for a drag racing track outside Boise, Idaho.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Adding a potentially important piece to the puzzle, researcher Joe Stewart, who works for Dell SecureWorks, an Atlanta-based security firm and division of </span><a href="http://www.bloomberg.com/quote/DELL:US" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Dell Inc. (DELL)</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">, the computer technology company, last year uncovered a flaw in software used by Comment group hackers. Designed to disguise the pilfered data’s ultimate destination, the mistake instead revealed that in hundreds of instances, data was sent to</span><a href="http://topics.bloomberg.com/internet-protocol/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Internet Protocol</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;"> (IP) addresses in Shanghai.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Military Link?</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The location matched intelligence contained in the 2008 State Department cable published by WikiLeaks that placed the group in Shanghai and linked it to China’s military. Commercial researchers have yet to make that connection. The basis for that cable’s conclusion, which includes the U.S.’s own spying, remains classified, according to two former intelligence specialists.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Lanstein said that although the make-up of the Comment group has changed over time -- the logs show some inexperienced hackers in the group making repeated mistakes, for example --the characteristics of a single group are unmistakable. The code and tools used by Comment aren’t public, and anyone using it would have to be given entre into the hackers’ ranks, he said.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">By October 2008, when the diplomatic cable published by WikiLeaks outlined the group’s activities, the Comment group had raided the networks of defense contractors and the Department of State, as well as made a specialty of hacking U.S. Army systems. The classified code names for China’s hacking teams were changed last year after that leak.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Cybersecurity experts have connected the group to a series of headline-grabbing hacks, ranging from the 2008 presidential campaigns of Barack Obama and </span><a href="http://topics.bloomberg.com/john-mccain/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">John McCain</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;"> to the 72 victims documented last year by the Santa Clara, California-based security firm McAfee Inc., in what it called Operation Shady Rat.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Nuclear Break-In</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Others, not publicly attributed to the group before, include a campaign against North American natural gas producers that began in December 2011 and was detailed in an April alert by the Department of Homeland Security, two experts who analyzed the attack said. In another case, the hackers first stole a contact list for subscribers to a nuclear management newsletter, and then sent them forged e-mails laden with spyware.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">In that instance, the group succeeded in breaking into the computer network of at least one facility, Diablo Canyon nuclear plant, next to the Hosgri fault north of Santa Barbara, according to a person familiar with the case who asked not to be named.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Last August, the plant’s incident management team saw an anonymous Internet post that had been making the rounds among cybersecurity professionals. It purported to identify web domains being used by a Chinese hacking group, including one that suggested a possible connection to Diablo plant operator Pacific Gas & Electric Co., according to an internal report obtained by Bloomberg News.</span></div>
<h2 dir="ltr" style="line-height: 1.38; margin-bottom: 4pt; margin-top: 18pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Partial Control</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">It’s unclear how the information got to the Internet, but when the plant investigated, it found that the computer of a senior nuclear planner was at least partly under the control of the hackers, according to the report. The internal probe warned that the hackers were attempting “to identify the operations, organizations, and security of U.S. nuclear power generation facilities.”</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The investigators concluded that they had caught the breach early and there was “no solid indication” data was stolen, according to the report, though they also found evidence of several previous infections.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Blair Jones, a spokesman for PG&E, declined to comment, citing plant security.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Around the time the hackers were sending malware-laden e- mails to U.S. nuclear facilities, six people at the Wiley Rein law firm were ushered into hastily called meetings. In the room were an ethics compliance officer and a person from the firm’s information technology team, according to a person familiar with the investigation. The firm had been hacked, each of the six were told, and they were the targets.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Lawyers’ Files</span></h2>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Among them were </span><a href="http://topics.bloomberg.com/alan-price/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Alan Price</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;"> and Timothy Brightbill. Firm partners and among the best known international trade lawyers in the country, they’ve handled a series of major anti-dumping and unfair trade cases against China. One of those, against China’s solar cell manufacturers, in May resulted in tariffs on more than $3 billion in Chinese exports, making it one of the largest anti-dumping cases in U.S. history.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Dale Hausman, Wiley Rein’s general counsel, said he couldn’t comment on how the breach affected the firm or its clients. Wiley Rein has since strengthened its network security, Hausman said.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">“Given the nature of that practice, it’s almost a cost of doing business. It’s not a surprise,” he said.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">E-Mails to Spouses</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Tipped off by the researchers, the firm called the Federal Bureau of Investigation, which dispatched a team of cyber investigators, the person familiar with the investigation said. Comment hackers had encrypted the data it stole, a trick designed to make it harder to determine what was taken. The FBI managed to decode it.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The data included thousands of pages of e-mails and documents, from lawyers’ personal chatter with their spouses to confidential communications with clients. Printed out in a stack, the cache was taller than a set of encyclopedias, the person said.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Researchers watching the hackers’ keystrokes last summer say they couldn’t see most of what was stolen, but it was clear that the spies had complete control over the firm’s e-mail system. The logs also hold a clue to how the FBI might have decrypted what was stolen. They show the simple password the hackers used to encrypt the files: 123!@#. Paul Bresson, a spokesman for the FBI in Washington, declined to comment.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Following the Crisis</span></h2>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">In case after case, the hackers’ trail crisscrossed with geopolitical events and global headlines. Last summer, as the news focused on Europe’s financial crisis, with its import for China’s rising economic power, the hackers followed.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The timing coincided with an intense period for EU Council President </span><a href="http://topics.bloomberg.com/van-rompuy/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Van Rompuy</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">, set off by the failure July 11 of the EU finance ministers to agree on a second bailout package for Greece. Over the next 10 days, the slight and balding former Belgian prime minister presided over the negotiations, drawing European leaders, including German Chancellor </span><a href="http://topics.bloomberg.com/angela-merkel/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Angela Merkel</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">, to a consensus.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Although the monitoring of Van Rompuy and his staff occurred during those talks, researchers say that the logs suggest a broad attack that wasn’t timed to a specific event. It was the cyber equivalent of a wiretap, they say -- an operation aimed at gathering vast amounts of intelligence over weeks, perhaps months.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">’Big Implications’</span></h2>
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<a href="http://topics.bloomberg.com/richard-falkenrath/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Richard Falkenrath</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">, former deputy homeland security adviser to President </span><a href="http://topics.bloomberg.com/george-w.-bush/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">George W. Bush</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">, said China has succeeded in integrating decision-making about foreign economic and investment policy with intelligence collection.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">“That has big implications for the rest of the world when it deals with the country on those terms,” he said.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Beginning July 8, 2011, the hackers’ access already established, they dipped into the council’s networks repeatedly over 10 days. The logs suggest an established routine, with the spies always checking in around 9 a.m. local time. They controlled the council’s exchange server, which gave them complete run of the e-mail system, the logs show. From there, the hackers simply opened the accounts of Van Rompuy and the others.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Week of E-Mails</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Moving from one victim to the next, the spies grabbed e- mails and attached documents, encrypted them in compression files and catalogued the reams of material by date. They grabbed a week’s worth of e-mails each time, appearing to follow a set protocol. Their other targets included then economic adviser and deputy head of cabinet, Odile Renaud-Basso, and the EU’s counter-terrorism coordinator. It’s unclear how long the hackers had been in the council’s network before the researchers’ monitoring began -- or how long it lasted after the end of July last year.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">There’s no indication the hackers penetrated the council’s offline system for secret documents. “Classified information and other sensitive internal information is handled on separate, dedicated networks,” the council press office said in a statement when asked about the hacks. The networks connected to the Internet, which handle e-mail, “are not designed for handling classified information.”</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">What the EU did about the breach is unclear. Dirk De Backer, a spokesman for Van Rompuy, declined to comment on the incident, as did an official from the EU Council’s press office. A member of the EU’s security team joined the group of researchers in late July, and was provided information that would help identify the hackers’ trail, one of the researchers said.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">“No Knowledge”</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Zoltan Martinusz, then principal adviser on external affairs and one of two victims reached by Bloomberg who would address the issue, said, “I have no knowledge of this.” The other official, who wasn’t authorized to discuss internal security and asked not to be identified, said he was informed last year that his e-mails had been accessed.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The logs show how the hackers consistently applied the same, simple line of attack, the researchers said. Starting with a malware-laden e-mail, they moved rapidly through networks, grabbing encrypted passwords, cracking the coding offline, and then returning to mimic the organization’s own network administrators. The hackers were able to dip in and out of networks sometimes over months. The approach circumvented the millions of dollars the organizations collectively spent on protection.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Security Switched Off</span></h2>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">As the spies rifled the network of </span><a href="http://www.bens.org/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Business Executives for National Security Inc.</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">, a Washington-based nonprofit whose advisory council includes former Secretary of State </span><a href="http://topics.bloomberg.com/henry-kissinger/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Henry Kissinger</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;"> and former Treasury Secretary </span><a href="http://topics.bloomberg.com/robert-rubin/" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Robert Rubin</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">, the logs show them switching off the system’s Symantec anti-virus software. Henry Hinton Jr., the group’s chief operations officer, said in June he was unaware of the hack, confirming the user names of staff computers that the logs show were accessed, his among them.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The records show the hackers’ mistakes, but also clever tricks. Using network administrator status, they consolidated onto a single machine the computer contents of the president and seven other staff members of the International Republican Institute, a nonprofit group promoting democracy.</span></div>
<h2 dir="ltr" style="line-height: 1.38; margin-bottom: 4pt; margin-top: 18pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">220 Documents</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">With all that data in one place, the hackers on June 29, 2011, selected 220 documents, including PDFs, spreadsheets, photos and the organization’s entire work plan for China. When they were done, the Comment group zipped up the documents into several encrypted files, making the data less noticeable as it left the network, the logs show.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Lisa Gates, a spokeswoman for the IRI, confirmed that her organization was hacked but declined to comment on the impact on its programs in China because of concern for the safety of staff and people who work with the group. A funding document describes activities including supporting independent candidates in China, who frequently face harassment by China’s authorities.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">As a portrait of the hackers at work, the logs also show how nimbly they could respond to events, even when sensitive government networks were involved. The hackers accessed the network of the Immigration and Refugee Board of Canada July 18 last year, targeting the computer of Leeann King, an immigration adjudicator in Vancouver.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">King had made headlines less than a week earlier when she temporarily freed Chinese national Lai Changxing in the final days of a long extradition fight. Chinese authorities had been chasing Lai since he fled to Canada in 1999, alleging that he ran a smuggling ring that netted billions of dollars.</span></div>
<h2 dir="ltr" style="line-height: 1.38; margin-bottom: 4pt; margin-top: 18pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Cracking Court Accounts</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Monitoring by Cyber Squared Inc., an Arlington, Virginia- based company that tracks Comment independently and that captured some of the same activity as the researchers, recorded the hackers as they worked rapidly to break into King’s account. Beginning only with access to computers in Toronto, the hackers grabbed and decrypted user passwords, gaining access to IRB’s network in Vancouver and ultimately, the logs show, to King’s computer. From start to finish, the work took just under five hours.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Melissa Anderson, a spokeswoman for the board, said officials had no comment on the incident other than to say that any such event would be fully investigated. Lai was eventually sent back to China on July 23, 2011 after losing a final appeal. He was arrested, tried, and in May of this year, a Chinese court sentenced him to life in prison.</span></div>
<h2 dir="ltr" style="line-height: 1.38; margin-bottom: 4pt; margin-top: 18pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Controlling the Networks</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">In case after case, the hackers had the run of the networks they were rifling. It’s unclear how many of the organizations researchers contacted, but in only one of those cases was the victim already aware of the intrusion, according to one member of the group. Halliburton officials said they were aware of the intrusion and were working with the FBI, one of the researchers said. Marisol Espinosa, a spokeswoman for the publicly traded company, declined to comment on the incident.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">The trail last summer led to some unlikely spots, including Pietro’s, an Italian restaurant a couple of blocks from Grand Central station in New York. In business since 1932, guests to the dim, old-fashioned dining room can choose linguine with clam sauce (red or white) for $28. The Comment group stopped using the restaurant’s site to communicate with hacked networks sometime last year, said FireEye’s Lanstein, who discovered that the hackers had left footprints there. Traces are still there.</span></div>
<h2 dir="ltr" style="line-height: 1.38; margin-bottom: 4pt; margin-top: 18pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">’Ugly Gorilla’</span></h2>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Hidden in the webpage code of the restaurant’s site is a single command: ugs12, he said. It’s an order to a captive computer on some victim’s network to sleep for 12 minutes, then check back in, he explained. The ”ug” stands for “ugly gorilla,” what security experts believe is a moniker for a particularly brash member of Comment, a signal for anyone looking that the hackers were there, said Lanstein.</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">“We’re so good even hackers want us!” joked Bill Bruckman, the restaurant’s co-owner, when he was told his website had been part of the global infrastructure of a Chinese hacking team. “Hey, put my name out there -- any business is good business,” he said.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Bruckman said he knew nothing about the breach. A few friends reported trouble accessing the site about six months ago, though he said he’d never figured out what the problem was.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">Outside a moment later, smoking a cigarette, Bruckman added a more serious note.</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">“Think of all that effort and information going down the drain. What a waste, you know what I mean?”</span></div>
<b style="font-weight: normal;"><br /></b><br />
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">To contact the reporters on this story: Michael Riley in Washington at michaelriley@bloomberg.net; Dune Lawrence in New York atdlawrence6@bloomberg.net</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">To contact the editor responsible for this story: Melissa Pozsgay at mpozsgay@bloomberg.net; Michael Hytha at mhytha@bloomberg.net</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-left: 8pt; margin-right: 8pt; margin-top: 0pt; text-align: center;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 13.999999999999998pt; font-style: normal; font-variant: normal; font-weight: 400; text-decoration: none; vertical-align: baseline; white-space: pre-wrap; white-space: pre;">®2012 BLOOMBERG L.P. ALL RIGHTS RESERVED.</span></div>
<br />Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com58tag:blogger.com,1999:blog-7475395270631949054.post-59490774461886282672015-04-08T15:43:00.002-07:002015-04-08T15:43:13.181-07:00The Weak Economic Data Is Bullish For Stocks<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<br /></div>
<ul style="margin-bottom: 0pt; margin-top: 0pt;">
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The economic outlook is bleak.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Bond yields are likely to fall.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Falling bond yields are bullish for equities.</span></div>
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</ul>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The recent economic telemetry suggests weakness: </span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">> The Atlanta Fed </span><a href="https://www.frbatlanta.org/cqer/researchcq/gdpnow.cfm" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">forecasts</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> 0.1% growth for 1Q15.</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">> The PPI is negative and core inflation is zero.</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">> The CRB index is down 30% since July.</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">> Five-year expected inflation is 1.6%.</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">> The real funds rate has risen from -4% to 0% (per St Louis Fed).</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">> Employment growth is slowing and participation continues to decline.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">We are seeing the result of the premature withdrawal of fiscal and monetary stimulus in the face of a fragile recovery. Fiscal policy has been tightening for five years, and monetary policy has been tightening since 2012 (as measured by money growth). The credit aggregates have stopped shrinking but household credit has not resumed growth. The credit markets are still suffering from PTSD. Restrictive policy is the wrong medicine for this malady.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The data says to me that we are looking at negative shocks to inflation and the bond market which will push the 10-year yield back down to the 1.5% neighborhood. It has already fallen from 3% at the beginning of last year to 1.9% today. It has plenty of room to go lower: it fell as low as 1.4% in mid-2012. </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 15pt; margin-top: 12pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Generally speaking, falling bond yields are bullish for equity valuations because (1) they lower the discount rate for future cashflows; (2) they drive investors out of bonds; and (3) they raise the equity risk premium. Since the Crash, the 10-year yield has fallen from 3.5% to 1.9%, or by 45%, while over the same period the </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=232982" style="text-decoration: none;"><span style="background-color: white; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Wilshire US Large-Cap Total Market Index </span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">has risen from 17,000 to 60,000. </span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 15pt; margin-top: 12pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The equity risk premium (ERP) measures the difference between the long-term risk-free rate and the expected return from equities over a similar horizon. Damodaran at NYU uses 8% as the expected return from equities and the 10-year yield as the risk-free rate. The historical return from equities has been volatile and the choice of time period will produce different </span><a href="http://dqydj.net/sp-500-return-calculator/" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">results</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">. For example, the total equity return since the Crash has been 21% per annum. It is important to remember that the return from equities is price appreciation plus dividends. This is why the total return indices outperform price indices. </span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 15pt; margin-top: 12pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Damodaran calculates today’s ERP at 5.5%, which is mid-range for the post-Crash period but quite high for prior periods going back to 1961.</span></div>
<div dir="ltr" style="line-height: 1.38; margin-bottom: 15pt; margin-top: 12pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Because the expected return from equities has been set at 8%, changes in the ERP reflect changes in Treasury yields: lower yields = a higher ERP. Therefore the risk to equity valuations is not fluctuations in earnings, dividends or even prices; the risk is higher bond yields. To decide whether stocks are currently cheap requires the investor to make a judgement about future bond yields. When I look at the data dashboard today, I see many things that suggest lower yields and only a few things that suggest higher yields (falling unemployment and rising employment costs). Therefore, I believe that stocks remain attractive and should go higher in the event that economic weakness results in lower bond yields.</span></div>
<br />Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com11tag:blogger.com,1999:blog-7475395270631949054.post-78245934790619019542015-01-12T10:37:00.001-08:002015-01-12T10:37:07.604-08:00The Yellen Bond Bubble<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<br /></div>
<ul style="margin-bottom: 0pt; margin-top: 0pt;">
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Bond yields are dangerously low.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Prices are falling and inflation expectations have become unanchored.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The Fed will have to act, and bond prices will have to fall.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Stocks are more remunerative than bonds right now.</span></div>
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</ul>
<b id="docs-internal-guid-5532a0b9-df6e-9cf0-be81-e133f3f3be08" style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Bond prices have </span><a href="http://www.bloomberg.com/quote/BUSY:IND/chart" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">soared</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> and bond yields have </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=215655" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">declined</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> by one-third since Janet Yellen became Fed chairman. Over the past six months, </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=215654" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">five-year expected inflation</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> has declined from 2% (the Fed’s target) to 1.2%, a decline of 40%, and far below the Fed’s target. The Fed’s inflation target has lost credibility in the bond market.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">In 1933, Irving Fisher wrote about deflation risk: “The more the economic boat tips, the more it tends to tip.” On the same topic, Ben Bernanke said that “the best way to get out of trouble is not to get into it in the first place”. In other words, deflation is much easier to prevent than to correct, as the ECB is learning at this very moment.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">One of the Fed’s </span><a href="http://www.federalreserve.gov/monetarypolicy/files/FOMC_LongerRunGoals.pdf" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">stated goals</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> is to anchor expected inflation so as to avoid inflationary or deflationary pressures from building. Something happened in 2014 which caused inflation expectations to become unanchored, perhaps the premature taper of QE or the constant talk of a rate hike. It doesn’t really matter what caused expectations to become unanchored, because inflation expectations are the Fed’s job to manage, not an exogenous variable to be lamented. Deflation is a currency-specific monetary problem, and there is no such thing as “global deflationary pressure”. The Fed’s failure to anchor inflation expectations has created a big bond bubble that will need to be popped. </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">It is difficult to argue that the bubble won’t ever be popped because there is a “new normal” of low everything. The only way that we can have such a new normal is if the Fed were to permanently abandon its inflation target. Assuming it doesn’t do that, assuming that at some point it moves to raise inflation and expectations, the bubble will burst. We can’t live forever with five-year Treasuries </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=215660" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">yielding</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> 50 bips less than the Fed’s inflation target.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">I have just argued that the Fed will have to act in order to raise both expected inflation and bond yields. But please note that the bond market strongly disagrees with me: it has made it clear that it does not expect the Fed to do anything. If it agreed with me, we wouldn’t be seeing these frightening numbers.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Nonetheless, it is quite likely that, at some point this year, the FOMC will wake up and notice that things are slipping out of control, and will be forced to take decisive action to raise expected inflation. For example, it could eliminate interest on excess reserves and launch an open-ended QE. If such a policy proved successful, bond prices would fall substantially (and deflation risk would be banished).</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The do-nothing option is not really viable, because we are already seeing signs of deflation. Commodity and producer prices are falling, as is headline inflation (both CPI and PCE). How much of this is the transitory effect of falling oil prices and how much is a deeper phenomenon is not yet clear. But the fact that hourly </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=215682" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">wage rates</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> are falling suggests that this problem may go deeper than the oil situation. The price of oil has declined many times before without causing general deflation (aside from the Crash which was about a lot more than oil prices).</span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Investment Conclusion</span></div>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">When bond yields are below the Fed’s inflation target, I think bond prices have entered risky terrain. The current low yields make stocks a better investment alternative (with expected total return around 7-8%), but stock prices are also vulnerable to higher bond yields, because higher yields compress the equity premium. Nonetheless, I feel safer being overweight equities and underweight longer-dated bonds. Stocks are an investment which will over time reward you with cashflow irrespective of subsequent price movements. Don’t buy for appreciation, buy for total return. Note that the market’s current dividend yield is higher than the 5-year bond yield, and about the same as the 10-year.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><br /></span></div>
Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com16tag:blogger.com,1999:blog-7475395270631949054.post-63793451588495516262015-01-06T15:21:00.002-08:002015-01-06T15:41:40.568-08:00Janet Yellen’s Failure As Fed Chairman<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<br /></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The markets are signalling deflation risk.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The Fed’s 2% inflation target is no longer credible.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The Fed must reverse course and resume effective monetary stimulus.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The outlook for stocks and bonds remain bullish, with stocks being particularly attractive.</span></div>
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</ul>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The ongoing decline in inflation, expected inflation and bond yields provides clear evidence of the failure of Janet Yellen’s chairmanship of the Federal Reserve. When she became chairman one year ago, the </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=214775" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">10 year yield</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> was 3%; today it is 1.9%, a decline of 37%. Ten year </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=214777" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">expected inflation</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> was 2.3% (above the Fed’s 2% target); today it is 1.6%, far below the Fed’s inflation target. Under Yellen’s leadership the Fed’s inflation target has lost credibility in the bond market, which now believes that the rate of inflation will remain below target for the next decade.</span></div>
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<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">A brief glance at prices:</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The </span><a href="http://www.bloomberg.com/quote/CRY:IND/chart" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">CRB index</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> is down by 30% since June.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=214778" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">PPI </span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">is in negative territory.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<a href="https://research.stlouisfed.org/fred2/graph/?graph_id=214779" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Headline PCE</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> is negative.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<a href="https://research.stlouisfed.org/fred2/graph/?graph_id=214780" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Core PCE</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> is about to go negative.</span></div>
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</ul>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">I don’t care what Yellen thinks about economics, just as I didn’t care what Bernanke thought. I care about the seriousness of the FOMC’s commitment to meeting its 2% inflation target, and to anchor expected inflation at 2% or above as stated in its </span><a href="http://www.federalreserve.gov/monetarypolicy/files/FOMC_LongerRunGoals.pdf" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Policy Statement</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> of January 2014: “The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored.” Clearly this target is not being met, at great danger to the economy’s long-term growth trajectory.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><span class="Apple-tab-span" style="white-space: pre;"> </span></span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">As I have written before, the problem with the leadership of Bernanke and Yellen is their excessive emphasis on consensus with a minimum level of dissenters. By reaching for consensus, they have given the Austrians an effective veto over unconventional policy. And conventional policy hasn’t worked.</span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">There are two ways to fix this problem. One is to be like Greenspan and be autocratic. The other is to be like the Chief Justice and go for a simple majority, allowing the dissenters to dissent. Yes, there are drawbacks to both approaches, but the job of Fed chair is not popularity but policy success, which Yellen is not achieving. She is risking the Japanification of the US economy: a permanently stalled economy operating far below its potential growth rate.</span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The FOMC blathers on about its data-dependency, which is not true. In fact, the FOMC is path-dependent, because path stability supposedly lends to greater credibility. It is time that the committee wakes up and becomes data-dependent, which will require a 180 degree change in course. When the dashboard is flashing “DEFLATION”, it is not the time to tighten policy or to threaten to tighten it. Admit the truth: QE was ended prematurely, and the talk of a rate rise in 2015 was reckless.</span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">To reverse the steady decline in inflation expectations will require a program of shock-and-awe that would convince the market that the Fed will do whatever it takes to restore inflation expectations to a level above 2%. Such a policy should include:</span></div>
<b style="font-weight: normal;"><br /></b>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: decimal; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">An inflation target of 3% to be maintained until inflation expectations rise to the desired level. </span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: decimal; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">A statement by the committee that until inflation expectations return to the desired level, below-target unemployment and “overheating” will not be a concern (just as above-target unemployment is not a concern when inflation is too high). </span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: decimal; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">A zero remuneration rate on excess reserves, and the explicit possibility of a negative rate.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: decimal; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">A resumption of asset purchases at a monthly rate of $100 billion to be continued until expected inflation exceeds 2% at both the 5 and 10 year horizons. (Five year expected inflation is now 1.4%.)</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: decimal; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">A wider range of policy instruments to include a trade-weighted basket of foreign government bonds, gold, silver and ETFs.</span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><span class="Apple-tab-span" style="white-space: pre;"> </span></span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: decimal; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">A personal commitment from the chairman to raise inflation expectations, with the implicit threat of resignation if outvoted. </span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><span class="Apple-tab-span" style="white-space: pre;"> </span></span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: decimal; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Continuation of the ZIRP until the above goals are achieved.</span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">I think that such a program of shock-and-awe would raise inflation, expected inflation and bond yields. If it proved insufficient, more should be done with respect to both the scale of asset purchases and the variety of policy instruments. The point is to do what it takes, not just to “do something” and then throw up your hands as Draghi has done.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Unfortunately, the likelihood of the FOMC adopting a policy along the lines suggested above is very low. As the Fed’s credibility continues to fall, the reversibility of the decline in expectations becomes increasingly difficult, as Japan has shown since the introduction of QE, and as Bernanke warned in his famous Helicopter Speech. I am worried about the US following Japan and Europe down the road of a Fisherian problem.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Investment Implications</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Bonds: Deflation is bullish for bonds, as we have seen, with bonds having outperformed every asset class in 2014. Given my outlook for inflation, and given bond yields in Japan and Europe, US bond yields still have a long way to fall. </span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Stocks: The decline in the risk-free rate, ceteris paribus, widens the equity risk premium and makes stocks more attractive than alternative investments (bonds, cash, metals). It is undeniable that falling commodity prices will hurt the reported earnings of commodity producers such as oil & gas. I expect to see a lot of noncash impairment charges in the 4th quarter due to the writedown of intangibles, which may depress reported earnings (but not cashflow).</span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">However, I don’t see the risk of a material decline in the </span><a href="http://people.stern.nyu.edu/adamodar/" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">long-term expected return from US equities</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> which should remain where it has been for the past fifteen years at around 8% (even during the Crash). Thus, the risk free rate will decline while the expected equity return should not. A decline into an uncontrolled deflationary spiral would be devastating for stock prices, as we saw in the early thirties, in Japan and soon in Europe, but even this do-nothing Fed would step in to prevent that. There are no Germans on the FOMC. </span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">While I expect bond yields to fall further, I feel safer being in an instrument with an 8% expected return rather than one with a fixed coupon of a negligible amount. It is worth noting that the current dividend yield of the S&P 500 exceeds the yield for both the five and ten year T-bonds. We saw this briefly post-Crash, but the last time prior to that was 1956, a very good time to buy stocks assuming a long investment-horizon.</span></div>
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Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com5tag:blogger.com,1999:blog-7475395270631949054.post-42998219231058457142014-12-13T17:20:00.001-08:002014-12-13T17:25:41.252-08:00To My ReadersI am currently publishing my commentary at Seeking Alpha. Here is the link:<br />
http://seekingalpha.com/author/christopher-mahoney/articles<br />
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<br />Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com1tag:blogger.com,1999:blog-7475395270631949054.post-73596092555537629362014-12-08T00:40:00.001-08:002014-12-08T00:40:08.011-08:00Barry, Just Barry, and Nothing But Barry<span style="background-color: white;">"</span><span style="background-color: white; color: #141823; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;">I have little interest in streamlining government or in making it more efficient, for I mean to reduce its size. I do not undertake to promote welfare, for I propose to extend freedom. My aim is not to pass laws, but to repeal them. It is not to inaugurate new programs, but to cancel old ones that do violence to the Constitution, or that have failed their purpose, or that impose on the people an unwarranted financial burden. I will not attempt to discover whether legislation is ‘needed’ before I have first determined whether it is constitutionally permissible. And if I should later be attacked for neglecting my constituents' interests, I shall reply that I was informed that their main interest is liberty and that in that cause I am doing the very best I can" </span><br />
<span style="background-color: white; color: #141823; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;">-- Barry Goldwater, 1960.</span>Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com1tag:blogger.com,1999:blog-7475395270631949054.post-65591037457374281922014-11-18T15:50:00.003-08:002014-11-18T15:50:46.870-08:00The Senate Blue Dogs<span style="background-color: white; color: #141823; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;">The 14 Blue Dogs who voted for the Keystone Pipeline against Harry Reid and Obama. How many of them will become "independents" in January?</span><br style="color: #141823; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;" /><span style="background-color: white; color: #141823; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;">Alaska Sen. Mark Begich </span><br style="color: #141823; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;" /><span style="background-color: white; color: #141823; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;">Arkansas Sen. Mark Pryor</span><br style="color: #141823; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;" /><span style="background-color: white; color: #141823; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;">Indiana Sen. Joe Donnelly, </span><br style="color: #141823; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;" /><span style="background-color: white; color: #141823; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;">Missouri Sen. Claire McCaskill </span><span class="text_exposed_show" style="color: #141823; display: inline; font-family: Helvetica, Arial, 'lucida grande', tahoma, verdana, arial, sans-serif; font-size: 14px; line-height: 19px;"><br />Montana Sen. Jon Tester<br />Montana Sen. John Walsh<br />North Carolina Sen. Kay Hagan<br />North Dakota Sen. Heidi Heitkamp<br />Virginia Sen. Mark Warner<br />West Virginia Sen. Joe Manchin<br />Colorado Sen. Michael Bennet<br />Delaware Sen. Tom Carper<br />Pennsylvania Sen. Bob Casey<br />Louisiana Sen. Mary Landrieu</span>Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-12409346504926302522014-10-17T18:27:00.001-07:002014-10-17T18:27:30.367-07:00The Fed’s Inflation Target Is Losing Credibility[Published at Seeking Alpha on Oct. 13, 2014]<br />
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The Fed has been missing its inflation target for over two years.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Both bond yields and expected inflation have been falling.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Given Yellen’s weak leadership, the prospects for reflation are dim.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The equity premium is rising.</span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">This is how the FOMC </span><a href="http://www.federalreserve.gov/monetarypolicy/files/FOMC_LongerRunGoals.pdf" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">describes</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> its mandate with respect to inflation:</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">“The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate.”</span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">However the Fed has </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=200195" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">failed to achieve</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> the 2% target for the past two and a half years despite what it believes has been “massive monetary stimulus”. The most recent reading of the targeted inflation rate is 1.5%, which is 25% below the 2% target. The consistent failure to achieve the inflation target is eroding the Fed’s credibility and is lowering inflation expectations thus raising the real funds rate which is contractionary. The Fed is tightening in the face of a weak recovery. </span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">So far this year, the 10-year Treasury yield has </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=200196" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">declined</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> by 70 bips from 3.0% to 2.3% while 10-year expected inflation has </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=200197" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">declined </span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">by 30 bips from 2.3% to 2.0%. </span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The reason that the Fed has failed to hit its target is the combination of single-digit </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=200198" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">money growth</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> and declining </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=200199" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">velocity</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">. The economy is in a classic Keynesian liquidity trap which requires radical policy measures. Because both Bernanke and Yellen decided to give the hawks a veto over policy, radical measures are off the table and the Fed is heading in a decidedly European direction. Ten-year German </span><a href="https://research.stlouisfed.org/fred2/series/IRLTLT01DEM156N" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">bunds</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> currently yield less than 1% which suggests that Treasury yields may have further to fall.</span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">It is noteworthy that as bond yields have been declining, equity yields (e/p) are rising as the market has recently declined. Thus the </span><a href="http://people.stern.nyu.edu/adamodar/" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">equity premium</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> is both high and rising. This would be an excellent juncture to take profits from longer-term bonds and buy equities with the proceeds. While bond prices may rise further, equities are much more compelling given the current ~5.5% risk premium.</span></div>
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Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com1tag:blogger.com,1999:blog-7475395270631949054.post-82451165404465898142014-10-17T18:24:00.001-07:002014-10-17T18:24:15.200-07:00The Selloff Is Noise; Do Nothing<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The market’s price swings are normal and within historic range.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Value is unrelated to price, and is rising.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Do nothing now, but keep an eye out for deflation risk.</span></div>
</li>
</ul>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">There is nothing happening in the equity market these days that should matter to a buy-and-hold investor. If you’re a day-trader or a chartist, that’s different. But if you have your saving invested in the broad market, nothing is going on and you should do nothing.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The history of the post-Crash bull market is a history of steady price appreciation periodically interrupted by volatility. There have been many selloffs since March 2009, all of which were corrected. There were big selloffs in 2010, 2011, and 2012. This year, we have had slumps in January, April and July. Now we are having another one. The bottom of the January-February slump was 15400 (DJIA), while today’s price (10/15) is ~15,900. </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Price fluctuations do not matter for the buy-and-hold investor, because the intrinsic value of a stock is independent of its price. Notwithstanding the EMH, the market’s price often deviates from its value--sometimes for very long periods, such as the fifties when it was underpriced and the sixties when it was overpriced.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Today the market is either fairly valued or is in value territory, depending upon how one evaluates the data. The CAPE says it is overvalued, but it has been saying that since the Crash. If you followed the CAPE, you would have missed the 9000 point run-up in the Dow over the past five years. Today’s high multiples reflect the very low yields on offer in the bond market. Year-to-date, bond yields have declined by one-third from 3% to 2%, while expected equity returns remain around 8%. </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The ERP is a much better valuation index than the CAPE, and it continues to flash somewhere between “fairly valued” and “under valued”. At present, Damodaran’s ERP is around 5.5% (and rising), which is roughly the mean value for the post-Crash period. It’s been higher and it’s been lower, but it is not low. It was lower before the Crash, and was 2% in 1999 at the height of the tech bubble. I would worry if the ERP fell to 4% or below.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">What is happening in the market now is mainly noise, assuming that the Fed can muster the will to prevent deflation or near-deflation. On that assumption, we are seeing a rising equity premium as the earnings yield rises and bond yields fall. That suggests doing nothing. </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Fedwatch</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The number to watch is PCE</span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=201019" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;"> inflation </span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">which needs to stay where it is (1.5%) or to go higher. Should it fall below 1%, the forces of deflation might become too strong for the Fed to correct, given its feckless leadership and hawkish consensus. The declines in </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=201020" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">gold</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">, </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=201021" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">oil</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> and </span><a href="http://www.bloomberg.com/quote/CRY:IND" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">commodity</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> prices are worrying. The ball is squarely in the Fed’s court to take action to prevent deflation. (I discussed this problem in a recent </span><a href="http://seekingalpha.com/article/2557515-the-feds-inflation-target-is-losing-credibility" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">article</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">.)</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">___________________________________________________________</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Glossary</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">EMH: the efficient market hypothesis that says that equity prices correctly discount all available information.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<a href="http://www.multpl.com/shiller-pe/" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">CAPE</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">: the cyclically-adjusted price earnings ratio calculated by Robert Shiller at Yale, which uses ten years of inflation-adjusted earnings instead of the trailing 12 months.</span></div>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">ERP: the equity risk premium, which measures the difference between expected equity returns and bond yields. This measure is calculated by Aswath </span><a href="http://people.stern.nyu.edu/adamodar/" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Damodaran </span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">at NYU. </span></div>
<div>
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><br /></span></div>
Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-46205922717098297512014-10-07T10:56:00.001-07:002014-10-07T10:59:10.357-07:00Venezuela On The Brink<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The looming collapse of the Venezuelan economy provides an interesting case study. While many aspects of its crisis are typical in Latin American balance of payments crises (such as large fiscal deficits financed in foreign currency), there are other aspects that are peculiar to Venezuela. </span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The principal peculiar feature is that Venezuela (unlike all other Latin American economies) makes nothing and imports everything. The only export and the only source of government revenue is oil. The price of oil fluctuates, and oil production has been declining despite large reserves. If Venezuela were a capitalist country following orthodox policies, it could adjust to current account imbalances via the price mechanism: as oil revenue fell, the currency would depreciate and imports would be reduced by rising prices. In extremis, the currency could fall far enough that non-oil exports would develop and import-substitution would occur. </span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">However, markets do not function in Venezuela. It is a socialist economy with a fixed exchange rate and domestic price controls and subsidies. The currency cannot depreciate, and hence demand is managed by rationing and shortages. An orthodox economist would prescribe a steady pace of currency depreciation and steadily rising domestic prices. However, the Chavista regime was elected by and is supported by the poor who depend upon cheap imported staples and cheap domestic gasoline. The regime has been unable to adopt a conventional adjustment program and is instead heading toward a classic--and potentially catastrophic--foreign exchange crisis. </span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Venezuela’s liquid dollar reserves are extremely low and its access to the international debt market is limited to concessional loans from China and/or Russia. The bolivar has fallen to one US cent on the black market, versus the official rate of sixteen cents. </span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Moody’s assigns a rating of Caa1 to Venezuela’s dollar bonds, which means that they are at risk of default. On September 15th, Moody’s said that the Caa1 rating “reflects increasingly unsustainable macroeconomic conditions, including high inflation and multiple exchange rate regimes. As government policies have exacerbated these problems, the risk of an economic and financial collapse has greatly increased….Despite the government's relatively small external financing requirements, rising government liquidity risk reflects the deterioration of market access and elevated borrowing costs on Venezuela's external debt. Foreign exchange reserves have fallen to very low levels”.</span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">So it would appear that the central scenario for Venezuela would be the exhaustion of foreign exchange reserves, default on external debt, collapse of the currency, and substantially higher real domestic prices. The ability of the government to provide its people with subsidized staples would be greatly curtailed, with potentially dire consequences for political stability. </span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">With respect to the prospects for external support, the standard IMF/World Bank adjustment package seems unlikely given the kind of policy changes that would be required. Additional loans from China and/or Russia could postpone the crisis further, but would not resolve it. The underlying problem can only be addressed via severe domestic austerity, which would have undesired political consequences. </span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The regime has imported many Cuban officials to staff its security services, and it has been moving steadily in the direction of overt dictatorship. Opposition politicians have been jailed and the press is under siege. But it is unclear to me whether the state of affairs is such that the regime could survive an economic collapse in the way that the Castro family has. It should also be pointed out that Venezuela supplies Cuba with the cheap oil on which it depends for survival. That supply could be jeopardized if it meant subsidizing Cubans at the expense of the Venezuelan masses. Thus, a Venezuelan crisis would likely be followed by a Cuban crisis, which is a further reason why there will be no IMF bailout since the US would welcome regime change in both countries.</span></div>
<br />Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com3tag:blogger.com,1999:blog-7475395270631949054.post-75669328295758772242014-09-30T19:40:00.002-07:002014-10-17T18:30:43.485-07:00The Coming European Depression<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><i>[Published by International Banker on July 9, 2014]</i></span><br />
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><br /></span>
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Over the past five years, there has been a profound shift in the transatlantic bank regulatory regime. Following the 2008 crash, insolvent banks were recapitalized by governments, and bondholders and uninsured depositors were fully protected from credit losses. Indeed, a very large number of major banks in the US and Europe were rescued and recapitalized by governments during this period, at no loss to their creditors or depositors. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Subsequent to these unpopular bailouts, financial policy has shifted from protecting bank creditors to exposing them to loss in the event of a capital shortfall. This is variously called “private sector involvement”, “stakeholder bail-ins”, and “market discipline”.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The rationale for this shift is that taxpayer funds should not be spent to protect bondholders and depositors, that creditors should take losses prior to governments, and that creditors should “do their homework” before investing in a bank’s liabilities. This new policy is seen as fair and prudent, and it is expected to lead to better policy outcomes in future banking crises.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Going forward, bank creditors will be expected to discriminate between strong and weak banks on the basis of their external financial reporting. This concept extends even to uninsured retail depositors such as those that were wiped out in the Cyprus banking crisis.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The policy architecture of market discipline rests upon four fallacious assumptions: (1) bank creditors are skilled in bank credit analysis; (2) bank financial reporting is sufficiently transparent to enable creditors to discriminate between solvent and insolvent banks; (3) the default of a large bank upon its liabilities will not create contagion and a general bank run; and (4) a flight to quality would not impact the real economy. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Each of these assumptions is erroneous: few bank creditors or depositors know much about bank credit analysis; bank financial reporting bears little relationship to bank solvency; a major bank default will likely result in runs on other banks perceived as weak or illiquid; and banking crises have macroeconomic ramifications–deflation and depression. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: bold; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Creditors Know Little About Bank Credit Analysis</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The foundation of bank credit analysis consists in the entering the reported financial data of a banking peer group (e.g., Irish banks) into a multi year database on a comparable basis, and then calculating ratios to enable comparison across banks and across time periods. This, by itself, is a monumental and labor-intensive task, and is generally performed by data vendors on a subscription basis. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Retail depositors have no access to these databases, and would not know how to use them if they did. There are credit rating agencies who perform their own bank credit analysis and offer credit opinions, but are the rating agencies supposed to be the foundation upon which rests future financial and macroeconomic stability? Do the authorities really intend to outsource financial and economic stability to the credit rating agencies? If not, then bank creditors and uninsured depositors will face a very steep learning curve indeed, and are likely to make serious mistakes. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: bold; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Bank Accounting And Bank Solvency Are Often Unrelated</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Banks typically report good profits and strong capital ratios prior to rescue or failure. An analysis of the financial reporting of failed or rescued banks will reveal that almost all of them were reportedly profitable and solvent before they failed. This is for two reasons: (1) failing banks generally accrue interest on bad loans, recognizing this fictitious interest as income; and (2) such banks generally hide their bad loans and do not create remotely adequate loss provisions prior to their recaps (see: Bankia, Banca MPS, WestLB, Depfa, RBS, Anglo-Irish, BofA, Citi, etc.).</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">This is why, when a bank fails and has to be resolved, the cost of resolution will typically reveal an insolvency much deeper than ever suggested in its public financial statements. Often the insolvency is a multiple of the bank’s reported capital; the difference between 6% and 8% capital under such circumstances is irrelevant. Speaking from my personal experience, the single best source of information about bank solvency is market rumor–because that’s generally all there is besides the official lies.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: bold; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Uncontained Bank Failures Create Contagion</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">When a major bank is allowed to default upon its liabilities, the market reacts by withdrawing credit from banks with a similar profile. This phenomenon occurred most recently in 2008, when the bankruptcy of Lehman Brothers Holdings lead to a withdrawal of credit from the other Wall Street banks, which necessitated the TARP bailout and the extension of extraordinary credit from the Fed. In a banking crisis, the mutual withdrawal of credit tends to be indiscriminate and fear-driven. The idea that, in the midst of a financial crisis, participants will choose to make fine distinctions between banks is not borne out by historical experience. In a flight to quality, many dominoes will totter. If one weak bank defaults, the market will attack the rest of the herd. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: bold; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Banking Crises Have Macroeconomic Ramifications</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Banking crises affect the macroeconomy in two crucial ways: credit contraction and monetary contraction. Following the shocks of the Lehman and Greek crises, credit contracted in both Europe and the US in what is characterized as a “Minsky Moment”. Prior to the shocks, credit growth was strong; after the shocks credit growth turned negative (credit growth did not merely decline; the credit aggregates contracted). Borrowers who were considered bankable before the shock instantly became unbankable afterwards. The desire of creditors to call in their loans during a crisis has immediate implications for confidence and growth because forced asset liquidations are deflationary. Economies cannot grow when credit is contracting. The “healing process” is in fact a prolonged disease.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Secondly, banking crises interfere with the efforts of the authorities to maintain adequate money growth as banks seek to shrink their balance sheets. Unless heroic measures are taken by the authorities to force money into the system, the money supply will contract along with the banking system, thus unleashing powerful deflationary forces. We saw this briefly in the US in 2009, and we are seeing such a deflationary spiral today in southern Europe, where money growth, inflation and economic growth are all near or below zero–and this is without any major bank failures so far. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: bold; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The Coming European Depression</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">We are now awaiting the results of the ECB’s asset quality review of the largest banks in the Eurozone which, if it is honest, will reveal large unrealized loan losses at many banks, and not just in the Club Med countries. In some cases, it is likely that these banks will be unable to raise sufficient additional equity to restore their solvency, thus creating the preconditions for a bail-in, whereby creditors would be required to transform their debt claims into equity. Should the bail-in policy result in major debt defaults, the consequences will be highly contractionary no matter what the ECB does.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The European authorities have created a lethal policy brew, imposing deflationary monetary policies while withdrawing the financial safety net, repeating the American experiment of 1930-33. As Irving Fisher wrote in 1933:</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">“Unless some counteracting cause comes along to prevent the fall in the price level, a depression tends to continue, going deeper, in a vicious spiral, for many years. There is no tendency of the boat to stop tipping until it has capsized. Only after almost universal bankruptcy will the indebtedness cease to grow. This is the so-called natural way out of a depression, via needless and cruel bankruptcy, unemployment, and starvation.” (The Debt-Deflation Theory Of Great Depressions)</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 11pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">There are two ways that Europe’s banking problems can be resolved: by default or by inflation. Inflation is regarded as sinful and “the easy way out”. Why take the easy way out when depression is so much more painful? Europe has chosen the path of default, deflation and depression, and in the process will relearn the lessons that Professor Fisher identified over eighty years ago.</span></div>
<span id="docs-internal-guid-82510265-c993-5292-b53b-6aab2b3c870b"><br /></span>Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com6tag:blogger.com,1999:blog-7475395270631949054.post-37030842661307725262014-09-09T11:35:00.001-07:002014-09-09T11:35:53.012-07:00The Scottish Referendum May Already Be A Black Swan<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<br /></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">A binary risk with a credible adverse scenario is a real risk today.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">There is a real risk today of a Scottish Black Swan.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">It could happen before the referendum on September 18th.</span></div>
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<h1 dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 10pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Last week I </span><a href="http://seekingalpha.com/article/2473725-financial-implications-of-a-scottish-yes-vote" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">discussed</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> the financial implications of a Scottish “Yes” vote in the referendum on September 18th. Today I would like to discuss </span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: italic; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">the risk that exists today </span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">because of the referendum. There is no doubt in my mind that a Yes vote next week would constitute a Black Swan event for the UK capital market and possibly beyond. A Yes vote would materially raise the level of uncertainty associated with UK financial assets. I don’t think that is in doubt. </span></h1>
<h1 dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 10pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">But what I want to say today is this: The risk today of a Scottish Yes vote may be enough to move markets in advance of the referendum. A rational investor needs to think now about positioning his portfolio for a possible Yes vote. Such anticipatory market activity could have a self-fulfilling impact. For example, if investors worry that a run on Scotland could result in a deposit moratorium, a run could occur before the 18th. Furthermore, a run on Scotland could prompt a run on UK financial assets. Already the pound has </span><a href="http://uk.reuters.com/business/currencies/quote?srcAmt=1.00&srcCurr=GBP&destAmt=&destCurr=USD" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">fallen</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> by 6% over the past two months. I’m pretty sure that sterling will fall further next week in the absence of official intervention.</span></h1>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The Independent </span><a href="http://www.independent.co.uk/news/uk/scottish-independence/scottish-independence-foreign-investors-desert-british-economy-amid-fears-of-yes-vote-9720967.html" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">reports</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">: </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">“Figures from investment bank Societe Generale showing an apparent flight of investors from the UK came as Japan’s biggest bank, Nomura, urged its clients to cut their financial exposure to the UK and warned of a possible collapse in the pound. [Nomura] described such an outcome as a ‘cataclysmic shock’...Investors have been pulling out for weeks and months, according to data on UK stock market funds cited by Societe Generale, which show a worsening exodus of global money from shares in British companies. From its best position this year of a little under $14bn (£8.6bn) flowing out from the UK earlier this year, the flight has accelerated to nearly $20bn (£12bn).”</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">This is still small potatoes, but the Yes risk is only now being analyzed in board rooms and investment committees around the world.</span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Thus, the risk today is not that Scotland ultimately redenominates, but rather that there can be no insurance against such a scenario, and that poses a risk right now. Two weeks from now, the risk could be gone, or it could be very real. </span><a href="http://uk.reuters.com/article/2014/09/03/uk-scotland-independence-goldman-idUKKBN0GY1VZ20140903" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Goldman</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">: </span><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">“Even if the Sterling monetary union does not break up in the event of a ‘Yes’ vote, the threat of a breakup would provide investors with a strong incentive to sell Scottish-based assets, and households with a strong incentive to withdraw deposits from Scottish-based banks.”</span></div>
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<a href="https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_166817" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Moody’s</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">: “The new Scottish government would, in all likelihood, need to issue its own currency, into which many if not all domestic private sector debts would be redenominated….One form of debt that would certainly face redenomination risk is bank deposits...It is inevitable that at least some types of deposits would come to be denominated in Scottish currency rather than pound sterling.”</span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">I may be an alarmist from time to time, but I would not accuse Nomura, SoGen, Goldman or Moody’s of being alarmist. The next ten days could be very exciting, especially in London.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><span class="Apple-tab-span" style="white-space: pre;"> </span></span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><span class="Apple-tab-span" style="white-space: pre;"> </span></span></div>
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<br />Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com4tag:blogger.com,1999:blog-7475395270631949054.post-4537308271939479592014-09-04T11:13:00.002-07:002014-09-04T11:13:29.335-07:00Financial Implications Of A Scottish Yes Vote<h1 dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 10pt;">
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">A Yes vote would create great uncertainty about the future of the Scottish financial system.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Both a new currency and sterlingisation are very risky.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The shock could be immediate.</span></div>
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<h1 dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 10pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Should we be spending our time worrying about Scottish independence? I’ve got to say yes, because it is a major contingent risk that should be understood before it happens, if it happens. The polls are quite close, and the referendum is only weeks away.</span></h1>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">I don’t want to discuss the long-term issues such as viability or governance. I’d prefer to focus now on the short-term risks. Goldman Sachs has just published a paper on the short-term risks of a Yes vote. Among other risks, it discusses the adverse implications for Scottish assets and Scottish banks:</span></div>
<h1 dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 10pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">“Even if the Sterling monetary union does not break up in the event of a ‘Yes’ vote, the threat of a break-up would provide investors with a strong incentive to sell Scottish-based assets, and households with a strong incentive to withdraw deposits from Scottish-based banks. The Bank of England would retain responsibility for the whole of the UK financial system until 2016 (at least), so it would be able to prevent the worst of the short-term consequences. However, the decision as to whether Scotland remains part of the Sterling monetary union will ultimately be a political one, so the BoE would be unable to credibly commit to the currency union remaining unbroken (implying some negative consequences for Scottish-based assets, even in the short term).”</span></h1>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Douglas Flint, chairman of HSBC, recently wrote in the Telegraph that “</span><span style="background-color: white; color: #282828; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">At the extreme, uncertainty over the Scotland’s currency arrangements could prompt capital flight from the country, leaving its financial system in a parlous state.” </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">So if you’re looking for something to worry about,, you should worry about the immediate future of the Scottish financial system. Yes, maybe the UK will relent and agree to monetary union. But right now, the risk is not that the monetary union will break up, but that it might. The UK has said that monetary union is off the table, and the EU has said that Scotland must have its own central bank. Remember that the EU wants to discourage regional secession from its member states. Almost every country in Europe has a region that seeks greater autonomy-- or worse. Scotland will have no friends in Brussels or Frankfurt.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Whether Scotland decides to print its own money, or whether it decides to unilaterally adopt sterling, there are substantial risks to holders and issuers of Scottish financial assets. If Scotland decides to print its own money, the currency will be entirely novel, and Scottish monetary and fiscal policy are complete unknowns. If Scotland instead decides to unilaterally “sterlingise”, its banks will lack a lender of last resort. In either case, there are substantial risks. A Yes vote would create great uncertainty for a very long time.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">In addition, the rump UK’s credit would suffer if Scotland chose to repudiate its debt, which has been discussed. This would leave the UK with a higher debt-to-GDP ratio, since the UK can’t repudiate its own debt. Every pound of UK debt is a liability of HM Treasury. </span></div>
<br />Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-56598132269118907272014-08-27T11:27:00.002-07:002014-08-27T11:27:57.699-07:00The Taper Is Bullish For Both Bonds And Stocks<ul style="margin-bottom: 0pt; margin-top: 0pt;">
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Conventional wisdom says that the Fed’s taper is bearish for bonds and stock.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">In fact, the taper is bullish for stocks and bonds.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Falling bond yields do not signal higher bond yields.</span></div>
</li>
</ul>
<b id="docs-internal-guid-1b444d0c-18b7-a951-b5fe-1e2d12bb9b8c" style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The common wisdom for understanding the behavior of the capital market since the Crash: “The Fed launched QE in order to artificially depress bond yields, resulting in the lowest bond yields in modern history. The tapering, ending and reversal of QE will remove this source of artificial demand, resulting in higher bond yields. The stock market has also been propped up by QE and will decline once this stimulus is withdrawn.”</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The common wisdom, however, is untrue. The intended (if unspoken) purpose of QE was to lower the real funds rate by raising inflation expectations. Money printing is inflationary and raises expected inflation and thus bond yields. The withdrawal of QE is inherently deflationary and should lower inflation expectations and bond yields. </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">In his famous deflation speeches, Bernanke provided excellent explanations of the need to raise expected inflation in order to lower the real funds rate. In a nutshell: the real funds rate is the nominal rate minus expected inflation. To stimulate the economy requires a negative funds rate. When the nominal rate is zero, the only way to make it negative is by raising the expected rate of inflation. This is what Bernanke was trying to do with QE. He was ultimately able to get the real funds rate down to minus 2%, which was stimulative (but inadequate and too late).</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The tapering of monetary stimulus has resulted in lower bond yields. When the Fed began to taper in January, the 10-year bond yielded 3%. Now, eight months into the taper, the 10-year yields 2.4%, a decline of 20%. In January, TLT was at 102; today it is at 118. Bond prices have risen during the taper, and continue to rise. This is because when the Fed shuts down its printing press at the end of this year and then begins to reverse QE, the impact on money growth should be negative. It’s true that QE did little to goose money growth, but its ending and reversal are unlikely to be stimulative. Depending on which monetary aggregate one chooses, the Fed has been tightening since 2012 (M2) or since January (MB). Tighter money, lower inflation, higher bond prices.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">This discussion is not only relevant to the bond market; it is also crucial for equity valuation. There are now two schools of thought with respect to the level of stock prices: the CAPE school (bearish) and the ERP school (bullish). The CAPE school says that PE ratios are too high, while the ERP school says that today’s high PEs are justified by low bond yields. The CAPE fraternity says that today’s low interest rates are artificial and should be ignored in the calculation of expected equity returns. They argue that there is no rational justification for today’s elevated multiples. Once the Fed withdraws QE, bond yields will normalize and stock prices will fall. If they are right--if bonds yield rise--then the CAPE school would be vindicated. But that is not happening.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The equity valuation argument hinges on the outlook for bond yields (and inflation). In my view, falling bond yields provide conclusive evidence that the market does not expect higher bond yields. The evidence to date suggests that bond yields are already normalized and that the elevated equity premium will persist until stock prices rise to much higher levels. In a later article I will explain further why I don’t expect higher bond yields or higher inflation.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Investment Conclusion</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The taper has resulted in higher bond and stock prices. The end and eventual reversal of QE should provide further support.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">_____________________________________________________________</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Glossary:</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">QE: quantitative monetary easing via Fed purchase of government and mortgage securities.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">TLT: </span><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">an exchange-traded fund which seeks to track the investment results of the Barclays U.S. 20+ Year Treasury Bond Index.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">M2: the measure of the money supply used by the Fed and most economists.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">MB: the monetary base, which approximates the size of the Fed’s balance sheet.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">CAPE: Robert Shiller’s cyclically-adjusted price earnings ratio which uses 10 years of inflation-adjusted earnings rather than 12 months as in the trailing PE.</span></div>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">ERP: the equity risk premium which measures the difference between the expected return from stocks versus government bonds.</span></div>
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<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><br /></span></div>
Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-38020298539885435862014-08-21T11:20:00.002-07:002014-08-21T11:20:41.667-07:00Where Are We In The Credit Cycle?<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<br /></div>
<ul style="margin-bottom: 0pt; margin-top: 0pt;">
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The deleveraging process has ended, but overall credit growth remains low.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The culprits are the housing sector--and the Fed.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Low growth supports current bond and equity valuations.</span></div>
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</ul>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The US economy has begun to dig out from the post-Lehman deleveraging process, but the current level of overall credit growth is anemic. (I am using the Fed’s flow of funds </span><a href="https://research.stlouisfed.org/fred2/categories/32257" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">data series </span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">from FRED.)</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Total Credit Growth</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Total credit was growing at 10% before the Crash, contracted in 2009-10, and is now growing at 3.5%, which is low enough to be acting as a drag on money growth and the recovery. This is mainly due to the low level of activity in the mortgage sector.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Households</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Household credit was growing at 11-12% pre-crash and then contracted for four straight years: 2009-12. Only last year did the contraction end, and growth is now de minimis. The mortgage sector has not recovered from the collapse of the housing bubble. This is the main drag on growth today.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Corporations</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Corporate credit was growing at 14% before Lehman, contracted in 2009-10, and has since recovered to a healthy 9% growth rate. Business is not starved for credit. This is a major positive for overall growth.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Financial Sector</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">During the bubble, the financial sector was growing in the low teens, then contracted very sharply, and has not yet resumed growth. Like housing, the financial sector has not yet recovered from the crash.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Federal Government</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Pre-crash, federal debt was growing at a modest 3%. During the crash, it grew very rapidly (2009). Following the Fiscal Cliff, federal debt growth has fallen to 6% which is neither contractionary nor stimulative. One could say that government finance has normalized at “neutral”.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">I believe that the current low level of overall credit growth is acting as a drag on the Fed’s monetary policy by countering the Fed’s efforts to grow M2. Larry Summers has suggested that the US economy can only grow rapidly during credit bubbles. I don’t agree. I would reformulate that to say that the nominal economic growth rate will tend to grow at the nominal rate of aggregate credit growth. You can’t have economic growth without credit growth, but it need not become a bubble. We don’t need 12% household credit growth to achieve 6% NGDP growth; we can make by with household credit growth in the mid-single digits. </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">At present, aggregate credit growth is stalled at 3.5%. If it can accelerate (i.e., if housing and/or inflation can pick up) then I would expect to see the benefits of the quantity equation, resulting in higher nominal growth. Of course, that is almost a tautology. It would appear that everything hinges on the bugaboo of the bubble years: house price appreciation and the availability of mortgage credit. </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">I do not mean to contradict monetarism or to absolve the Fed of its unwillingness to accelerate money growth. I am only saying that by handcuffing itself the Fed is making the economy hostage to the housing market. The growth rate of the nominal economy is within the control of the Fed, if it is prepared to reflate. The Fed’s ongoing satisfaction with inadequate inflation means that we are swimming on our own. At present, neither the government nor the Fed are providing any stimulus. </span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Investment Implications</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">We are looking at an economic dashboard where almost every dial is on LOW: credit growth, money growth, velocity, inflation, nominal growth. This suggests to me that the outlook for inflation and bond yields remains low. This in turn supports current stock and bond valuations, and it explains why the bond market yawned when the FOMC minutes were published. The fact that the Fed is plotting to reverse QE is deflationary, not inflationary. In fact, I am reminded of the monetary fiasco of 1937-38, when the Fed hit the brakes much too soon. The FOMC continues to be “Austrian Lite”. Monetarism is nowhere to be found.</span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Bottom line: current bond and stock prices are supported by the low trajectory of credit and money growth. </span></div>
Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-33900326427221002342014-08-12T18:18:00.002-07:002014-08-12T18:18:57.029-07:00Letter To WSJ Concerning European Bank Accounting<section class="sector one column col10wide" style="background-image: none; border: 0px; color: #333333; float: none; font-family: Arial, Helvetica, sans-serif; font-size: 10px; margin: 0px auto; outline: 0px; padding: 0px; vertical-align: baseline; width: auto !important;"><header class="module articleHeadgroup" style="border: 0px; margin: 0px; outline: 0px; padding: 0px; position: relative; vertical-align: baseline;"><div class="zonedModule" data-module-id="12" data-module-name="resp.module.article.ArticleColumnist" data-module-zone="articleheader" style="border: 0px; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">
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LETTERS</h2>
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Failure and Bailout of Banco Espírito Are No Surprise</h1>
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One of the typical occurrences in financial crises is for central banks and governments to offer assurances that things are all right, when in fact a disaster is approaching.</h2>
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Aug. 10, 2014 2:04 p.m. ET</div>
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In your editorial <a class="icon none" data-ls-seen="1" href="http://online.wsj.com/articles/espirito-santos-lousy-bailout-1407182109" style="color: #115b8f; margin: 0px; outline: none; padding: 0px; vertical-align: baseline; word-wrap: break-word;" target="_new">"Another Lousy Bank Bailout"</a> (Aug. 5), you criticize the Portuguese government's decision to protect senior bondholders in the resolution of <a class="t-company" data-ls-seen="1" href="http://quotes.wsj.com/PT/BES" style="color: black; margin: 0px; outline: none; padding: 0px; text-decoration: none; vertical-align: baseline; word-wrap: break-word;">Banco Espírito Santo</a>. You say that "Bondholders also aren't guaranteed, or shouldn't be, and forcing them to take losses would also be a welcome lesson in risk management." I see your point in principle, but I would observe that in practice market discipline cannot operate in a market in which the financial reporting provides no useful information to investors. This has been the case with European bank accounting.</div>
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The European Central Bank is now conducting an "in depth" asset quality review and stress test of the major euro zone banks. Will these efforts provide investors with sufficient information to discriminate between the strong and the weak, such that they can be left to fare for themselves? Given the ECB's prior stress tests, which almost every bank passed, I doubt it. European bank analysis must rely to a great deal on rumor and hearsay until the accounting becomes credible. Market discipline leads to crisis when the financial accounting is useless.</div>
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<strong style="border: 0px; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">Christopher T. Mahoney</strong></div>
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<em style="border: 0px; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">Wellsville, Pa.</em></div>
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<em style="border: 0px; margin: 0px; outline: 0px; padding: 0px; vertical-align: baseline;">Mr. Mahoney led Moody's Investors Service's bank rating practice from 1994-2007.</em></div>
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</section>Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-81325491253455381332014-08-01T13:08:00.003-07:002014-08-01T13:08:56.454-07:00Now Is The Time To Buy Stocks, Not Sell Them<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<br /></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The market selloff was prompted by noise rather than real data.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">On a YoY basis, the signals remain in range.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">There is no call for higher bond yields.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Stocks remain cheap to bonds.</span></div>
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</ul>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Once again, the bond market has demonstrated that it has a higher IQ than the stock market. Three numbers came out (second quarter growth, the July employment report, and the second quarter employment cost index) which spurred fears of higher inflation and interest rates, prompting a 500-point selloff in the DJIA. The bond market reacted much more calmly because bond investors study the data rather than reacting to a headline.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The data indicates that nothing has happened that would lead to higher interest rates. One can grow old quickly if he annualizes single data points. Annualized growth and employment data have a high noise to signal ratio when observed in isolation. I much to prefer to view the data on a year-on-year basis. This removes most of the noise and makes the trend visible and intelligible. On a YoY basis, there is no real news in the latest data.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Economic growth remains low, with NGDP growing at 4% and RGDP growing at 2.4%. Nominal growth at 4% is abysmal for an economy in recovery. In the post-inflation era (1983-2006), the economy often grew at 6-7%, which left plenty of room for 4% real growth. With 4% nominal growth, the post-Crash output gap will never close. We are in a new era of low money growth, steadily declining velocity, low inflation and low growth. This is not a promising environment for higher interest rates. Yes, the Fed is winding down QE. If that has any impact on money growth (doubtful), it will be negative, which means deflationary. So the end of QE is a reason to buy bonds, not to sell them.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Next, the employment data. Employment grew by 1.9% in July on a YoY basis, and by 1.8% on an annualized basis. This is within the range of employment growth since the recovery began. It is not a spike. There is no employment boom.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The employment cost index (all civilians) rose by 3% on an annualized basis, but by only 2.1% YoY. The 3% annualized rate is the highest since the Crash, but the 2.1% YoY rate is still within range. And price inflation? Core PCE inflation for June was 1.5%, which remains 25% below the Fed’s target. </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">So, in sum, there is very little news when you extract the headline-grabbing noise in the most recent data. We are on a stable path of low growth and low interest rates. </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Tomorrow, Professor Aswath Damodaran will publish his estimate of the equity premium for today at the closing bell. It should be quite a bit higher than it was on July 1st (5.45%), given the selloff. I expect it to approach 6%, which is historically high and means that we are being paid a lot of money to hold stocks versus bonds.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Investment Conclusion: Don’t panic. Buy stocks.</span></div>
<br /><br /><br />Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-29465830695743117572014-07-30T20:59:00.002-07:002014-07-30T20:59:45.399-07:00What's Up With Velocity?<div dir="ltr" style="line-height: 1; margin-bottom: 6pt; margin-top: 6pt;">
<span style="background-color: white; color: #222222; font-family: 'Times New Roman'; font-size: 19px; font-style: italic; line-height: 1; white-space: pre-wrap;">[Parts of this post are plagiarized from the Wikipedia entry for ‘Liquidity Preference” for which I offer no apology. I vouch for the correctness of what I have plagiarized.]</span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 6pt; margin-top: 6pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">In</span><a href="http://en.wikipedia.org/wiki/Macroeconomic_theory" style="text-decoration: none;"><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> macroeconomic theory</span></a><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">, </span><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: italic; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">liquidity preference</span><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> refers to the</span><a href="http://en.wikipedia.org/wiki/Money_demand" style="text-decoration: none;"><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> demand</span></a><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> for</span><a href="http://en.wikipedia.org/wiki/Money" style="text-decoration: none;"><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> money</span></a><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">, considered as</span><a href="http://en.wikipedia.org/wiki/Liquidity" style="text-decoration: none;"><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> liquidity</span></a><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">. The concept was first developed by</span><a href="http://en.wikipedia.org/wiki/John_Maynard_Keynes" style="text-decoration: none;"><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> John Maynard Keynes</span></a><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> in his book</span><a href="http://en.wikipedia.org/wiki/The_General_Theory_of_Employment,_Interest_and_Money" style="text-decoration: none;"><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> </span><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: italic; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The General Theory of Employment, Interest and Money</span></a><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> (1936) to explain determination of the</span><a href="http://en.wikipedia.org/wiki/Interest_rate" style="text-decoration: none;"><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> interest rate</span></a><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> by the</span><a href="http://en.wikipedia.org/wiki/Supply_and_demand" style="text-decoration: none;"><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> supply and demand</span></a><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> for money. The</span><a href="http://en.wikipedia.org/wiki/Demand_for_money" style="text-decoration: none;"><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> demand for money</span></a><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> as an asset was theorized to depend on the interest foregone by not holding</span><a href="http://en.wikipedia.org/wiki/Bond_(finance)" style="text-decoration: none;"><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> bonds</span></a><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">. Instead of a reward for saving, interest, in the Keynesian analysis, is a reward for parting with liquidity.</span></div>
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<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">According to Keynes, demand for liquidity is determined by three motives:</span></div>
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<li dir="ltr" style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: decimal; margin-left: 47px; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1; margin-bottom: 1pt; margin-top: 3pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The transactions motive: people prefer to have liquidity to assure basic transactions, for their income is not constantly available. The amount of liquidity demanded is determined by the level of income: the higher the income, the more money demanded for carrying out increased spending.</span></div>
</li>
<li dir="ltr" style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: decimal; margin-left: 47px; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1; margin-bottom: 1pt; margin-top: 3pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The precautionary motive: people prefer to have liquidity in the case of social unexpected problems that need unusual costs. The amount of money demanded for this purpose increases as income increases.</span></div>
</li>
<li dir="ltr" style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: decimal; margin-left: 47px; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1; margin-bottom: 1pt; margin-top: 3pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Speculative motive: people retain liquidity to speculate that bond prices will fall. When the interest rate decreases, people demand more money to hold until the interest rate increases, which would drive down the price of an existing bond to keep its yield in line with the interest rate. Thus, </span><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: bold; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">the lower the interest rate, the more money demanded</span><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> (and vice versa).</span></div>
</li>
</ol>
<div dir="ltr" style="line-height: 1; margin-bottom: 6pt; margin-top: 6pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The liquidity-preference relation can be represented graphically as a schedule of the money demanded at each different interest rate. The supply of money together with the liquidity-preference curve in theory interacts to determine the interest rate at which the quantity of money demanded equals the quantity of money supplied.</span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Monetary </span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">velocity is a function of the liquidity preference. When investors and businesses expect bond prices to fall, they maintain large cash holdings. When they expect bond prices to rise, they draw down their cash and invest in bonds. Today, velocity is low because of a high liquidity preference caused by the trauma of the Crash, and the perception that bond and stock prices are “too high”. In other words, a big part of M2 is not for transaction balances, but is rather a savings vehicle. This is exacerbated by the fact that the yield curve is low and flat. The opportunity cost of holding money is very low by historical standards. Going forward, market volatility should support low velocity, whereas a continued bull market should--at some point--begin to reduce the liquidity preference. Higher interest rates would also raise the opportunity cost of holding cash, and would increase velocity. Velocity will remain low until nominal growth returns to historical levels, which could be a long time.</span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Investment Conclusion</span></div>
<br />
<div dir="ltr" style="line-height: 1; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Economic growth has been retarded by the increase in the liquidity preference which has meant declining velocity in the face of growth in the monetary aggregates. The liquidity preference is a function of nominal interest rates, which are very low. The opportunity cost of holding cash versus bonds is minimal. The economy needs a much steeper yield curve, and it’s not going to happen. </span></div>
<div>
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><br /></span></div>
Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-88314609182197106702014-07-30T11:58:00.000-07:002014-07-30T11:58:10.469-07:00A Brief Note On The Second Quarter<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<br /></div>
<ul style="margin-bottom: 0pt; margin-top: 0pt;">
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Both nominal and real growth remain subdued.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">There are no signs of acceleration.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The bond market has over-reacted.</span></div>
</li>
</ul>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">On a YoY basis, </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=187520" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">RGDP</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> is growing at 2.4% and </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=187519" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">NGDP</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> is growing at 4%, far below the growth rates of the Clinton and Bush years. The low level of real growth reflects the low level of nominal growth, because you are not going to have 4% real growth along with 4% nominal growth. Nominal growth should be at least 6.5% if we ever wish to see 4% real growth again. The core problem is that the Fed’s 2% inflation target is much too low; and the FOMC has tolerated below-target inflation since the Crash. </span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Given that the economy has been stalled for the past four years, and given that the Fed is in the process of withdrawing stimulus, there is no reason to expect higher growth or inflation. Bond yields are unlikely to rise substantially against such a backdrop, and today’s selloff will prove to be a blip.</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Investment Conclusion</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The economy is not accelerating at a pace that should raise bond yields. Low bond yields sustain the wide equity premium (5.4% according to Aswath </span><a href="http://people.stern.nyu.edu/adamodar/" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Damodaran</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">). </span></div>
<br />Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-91728495121468614832014-07-27T12:15:00.004-07:002014-07-27T17:38:54.397-07:00Janet Yellen: The Manchurian Candidate?<div dir="ltr" style="line-height: 1.15; margin-bottom: 15pt; margin-top: 0pt;">
<br /></div>
<ul style="margin-bottom: 0pt; margin-top: 0pt;">
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 15pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Both the Right and Left see Yellen as a radical departure from her predecessors.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 15pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">But she is just another Bernanke and she won’t upset the apple cart.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 15pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">We can expect to see nothing radical coming out of the FOMC in the foreseeable future.</span></div>
</li>
</ul>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 15pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Janet Yellen has recently been getting a lot of attention in the media from both the Right and the Left. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 15pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">On the Left, the New Yorker recently published a </span><a href="http://www.newyorker.com/magazine/2014/07/21/the-hand-on-the-lever" style="text-decoration: none;"><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">profile</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> by Nicholas Lemann which painted Yellen and her economist husband in liberal if not leftist colors: “</span><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Yellen is notable not only for being the first female Fed chair but also for being the most liberal since Marriner Eccles.” Lemann reports that Yellen’s Nobel Prize winning husband, George Akerlof, called the Bush Administration “the worst government the U.S. has ever had in its more than 200 years of history”. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 15pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Lemann, who does not appear to be a close student of economics (“Economic management sounds technical, but it also has the quality of a powerful fable”), gets a bit confused when trying to make the case that there are “liberal” and “conservative” monetary policies. He tries to paint Milton Friedman as a conservative and Yellen as a liberal, when in fact they are both monetarists. Lemann is groping for the monetarist vs Austrian dichotomy, but he doesn’t have command of the scholastic nomenclature. In any case, he paints the Democrat Yellen as being to the left of the Republican Bernanke, and says that this has profound policy implications.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 15pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">On the Right, Peter Schiff (a conservative hard-money pundit) recently published a </span><a href="http://finance.townhall.com/columnists/peterschiff/2014/07/26/yellen-where-no-man-has-gone-before-n1865999/page/full" style="text-decoration: none;"><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">column</span></a><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> in which he takes the Lemann interview and runs with it. His column is a broad-ranging indictment of the new chairman as a dangerous liberal, leftist and inflationist: </span><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">“She is very different from any of her predecessors in the job. Put simply, she is likely the most dovish and politically leftist Fed Chair in the Central Bank's history...She does not seem to see the Fed's mission as primarily to maintain the value of the dollar, promote stable financial markets, or to fight inflation. Rather she sees it as a tool to promote progressive social policy and to essentially pick up where formal Federal social programs leave off.”</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 8pt; margin-top: 8pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Schiff deplores QE, saying that it “has prevented the government from having to raise taxes sharply or cut the programs she believes are so vital to economic health”, while “pushing up prices for basic necessities such as food, energy, and shelter”. He says that, as a liberal, Yellen focuses exclusively on employment: “Yellen clearly sees jobs as her top priority. Any hope that she will put these priorities aside and move forcefully to fight inflation when it officially flares up should be abandoned.” He expects her to pursue radically stimulative policies.</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 8pt; margin-top: 8pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Obviously, a big part of the problem here is that not a lot of pundits understand monetarism (or Keynesianism). There is a strong desire to cast the FOMC as a battleground between the right and the left, much like the Supreme Court where there are “Democratic” and “Republican” justices. This analysis founders, of course on the fact that many “Republican” economists are monetarists, such as Friedman, Greenspan, Bernanke and many others, and that Republican presidents have nominated many monetarists to the Board of Governors. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 8pt; margin-top: 8pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The sad fact is that, despite the hopes of the Left and the fears of the Right, Yellen is another Bernanke, a radical monetarist who abandons all of his core beliefs the day he first sits down in the chairman’s seat. Lemann is wrong that Yellen will speed up growth, and Schiff is wrong that she will cause inflation. I hope that both of their predictions prove true, but I’ll bet two-to-one against it. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 8pt; margin-top: 8pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Bernanke had the best shot we will ever see of implementing radical reflationary policies, and he failed. He recanted almost everything he had preached as an academic about price-level targeting and the need to do whatever is necessary to oppose deflationary forces. If Bernanke couldn’t do it, in face of the Great Recession, there is no way that Yellen is going to do it. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 8pt; margin-top: 8pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">That is because the #1 job of the Fed chair is not to grow the economy, but to maintain consensus in the committee and credibility on Capitol Hill. If Yellen were to form a growth caucus on the FOMC and ram through policies intended to get the economy moving again, the GOP would would pass legislation which would remove policy discretion and perhaps even the employment mandate. Such bills have already been introduced. This may happen even if Yellen stays on the reservation, but the probability would rise exponentially if she allowed inflation to hit 4%, which is now defined as hyperinflation. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 8pt; margin-top: 8pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Yellen and the monetarists know that, were they to incite such legislation, the future policy consequences could be dire. So they won’t. Instead we will see the end of QE, continued interest on excess reserves, and increasing pressure to “normalize" the Fed’s “bloated” balance sheet, despite the fact that money growth has been declining for the past two years, inflation has been below target and--most recently--both nominal and real growth have been negative. </span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 8pt; margin-top: 8pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Investment Conclusion</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 8pt; margin-top: 8pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Because the Fed will not pursue reflationary policies, inflation, inflation expectations and bond yields will remain very low, while the wide equity premium will persist until stock prices go materially higher.</span></div>
<span id="docs-internal-guid-e4a86ba7-793f-4352-90b3-cc92e7daf60a"><br /><br /><br /></span>Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-59557676567227525702014-07-16T10:07:00.002-07:002014-07-16T10:18:17.062-07:00Bond Yields Don’t Rise When The Fed Tightens Prematurely<h3 dir="ltr" style="line-height: 1; margin-bottom: 0pt; margin-top: 8pt;">
</h3>
<ul style="margin-bottom: 0pt; margin-top: 0pt;">
<li dir="ltr" style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Many pundits are predicting stronger growth and higher bond yields.</span></div>
</li>
<li dir="ltr" style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">They are misreading the monetary data.</span></div>
</li>
<li dir="ltr" style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The FOMC is withdrawing stimulus in the face of slowing growth.</span></div>
</li>
<li dir="ltr" style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The outlook is for low money growth, low inflation, low nominal growth and low bond yields.</span></div>
</li>
<li dir="ltr" style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">This is bullish for both stocks and bonds.</span></div>
</li>
</ul>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">There is a growing chorus among the economic pundits that the economy is picking up steam, that monetary policy should “normalize”, and that bond yields “will have to normalize”. This consensus is not supported by the data.</span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Nominal growth, inflation and bond yields are artifacts of monetary policy. Monetary policy today is restrictive and becoming more so. If the quantity equation holds, then we won’t be seeing any pickup in nominal growth that could justify higher bond yields. Anyone who thinks that the first quarter growth numbers were caused by “winter” isn’t looking at current monetary policy. (This may come as a shock to Al Gore, but the government still seasonally adjusts the quarterly GDP data.)</span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The bottom line for the economic outlook is that the Fed is withdrawing stimulus in the face of falling growth. This is not a monetarist Fed; it is a hawkish Fed. While the FOMC is not as Austrian* as the ECB, the Austrian hawks on the FOMC have an effective veto over any policies intended to stimulate inflation and nominal growth--due to the institutional priority placed on consensus and “credibility”. </span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Despite the fact that both Bernanke and Yellen are dovish monetarists, the policy mix that we are seeing today and can expect to see in the future is Austrian Lite, which is a compromise between monetarism and Austrianism. We are going to get a continuation of low inflation, low nominal growth, and low bond yields. We will not see again the high levels of nominal and real growth that we saw during the Greenspan years. That is, not unless there is a radical change in the composition of the FOMC.</span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">There is nothing to stop the Fed from raising the funds rate, since this is within its complete control. But the impact of a rate hike in a weak economy is deflation and lower bond yields. A higher funds rate will not raise bond yields; it will just flatten the curve and create a recession.</span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">What is the policy stance of the FOMC today? Judging by its actions, as opposed to its palaver, the policy stance is to target an inflation rate below 2%, to grow the money supply in the mid-single digits, and to tolerate abysmal levels of nominal and real growth. In other words, Austrianism Lite. The policy is restrictive; the brakes are on. This is not monetarism. </span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Bush and Obama appointed dovish monetarists to the chairmanship, hoping for good growth and low unemployment. But the minute a dovish academic walks into the Eccles Building, he stops being an economist and becomes a consensus-seeking, controversy-avoiding "manager". The monetarists are institutionally captured, no matter what they truly believe about economics. The real job of the Fed chair is institutional credibility and continuity, not growth or other humanitarian desiderata. The last thing that a Fed chairman wants to be called is "controversial". This is analogous to the job of the chief justice: retain credibility and respect. </span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The post-crash FOMC has not completely ignored its full employment mandate, but mainly pays it lip service. It’s slogan (like that of the ECB and the pre-Abe BoJ) is “We’re doing all that we can do and monetary policy is not a panacea”. They are “creating the conditions” for recovery, but take no responsibility for making it actually happen. They are defying the quantity equation. I can only wish that Milton Friedman were still around to be able to explain to Bernanke and Yellen that the pace of nominal growth is within the control of the Fed. Friedman did not put the quantity equation on his license plate because he didn’t believe in it. </span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">So today we have 6% money growth, falling velocity and dangerously low nominal growth. In the face of that data, the Fed has decided to end its balance sheet expansion. The FOMC has declared victory and now plans to do nothing further. So why in the world should we expect nominal growth and bond yields rise in such circumstances? Let’s look at what the bond market thinks: 10-year yields have fallen from 3.0% to 2.6% this year. That does not suggest that the bond market expects a pickup in nominal growth let alone higher yields. Why would falling bond yields lead people to expect higher bond yields? Why would falling growth lead people to expect accelerating growth? It’s as if the data didn’t exist.</span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">Investment Conclusion</span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">We are living in a “new era” of slow money growth, low inflation, low nominal growth and low bond yields. Since low bond yields support high stock PE multiples, this news is bullish for both stocks and bonds, but stocks will continue to outperform bonds (because the equity premium is so high).</span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">________________________________________________________</span></div>
<div dir="ltr" style="line-height: 1; margin-bottom: 8pt; margin-top: 0pt;">
<span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">*Austrianism is the belief that the optimal policy of the monetary authority is price stability, rather than moderate nominal growth or full employment. (Paul Ryan, Rand Paul and Paul Gigot are Austrians.) Austrians reject the quantity equation (money growth = nominal growth) as simplistic and meaningless. They believe that if the central bank delivers price stability, the economy will grow at its “natural” pace and that growth should not be stimulated with "monetary steroids". They believe that recessions naturally occur and naturally correct without fiscal or monetary stimulus, and they recommend supply-side measures such as regulatory reform and lower taxes. This philosophy (once espoused by Herbert Hoover and his gang) has created 12% unemployment in the Eurozone, a shrinking nominal economy in Japan for two decades, and U6 unemployment in the US of 12% five years </span><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: italic; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">after</span><span style="background-color: white; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> the Crash.</span></div>
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<br />Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-83203570950128358902014-07-03T13:47:00.002-07:002014-07-03T14:03:25.849-07:00Ignore The June Employment Data<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<br /></div>
<ul style="margin-bottom: 0pt; margin-top: 0pt;">
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The June employment numbers are noise.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Employment growth remains slow.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">There is little risk of an inflation shock.</span></div>
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</ul>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">How should we interpret the strong employment growth figures for June? Does it suggest that the economy is accelerating, or even overheating? My answer is no to both. Employment growth remains slow, and the economy is not overheating.</span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Between 2003 and 2008, total </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183850" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">employment </span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">grew from 130 million to 138 million. Over the next two years the economy shed 8 million jobs and employment returned to 130 million. Since 2010, the economy has added back the 8 million jobs that were lost in the recession, and we are just above where we were six years ago. It has been a long and painful recovery, which reflects poorly on the stewardship of the FOMC (which consistently ignores its full employment mandate).</span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Since the Crash, employment on a YoY </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183911" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">basis</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> has been growing at between 1.5% and 2.0%. The June number, on a YoY basis, remains within range at 1.8%. On an annualized basis, monthly employment growth during the recovery has averaged below 2%, with a range between 0.6% and 3.3%. The June growth number was 2.5%, well within </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183906" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">range</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">. There is thus not a lot of information content in the June number; I see it as noise, just like the shrinkage of the economy in 1Q14.</span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The economy and employment (nominal) continue to be stuck in second gear, growing far below the</span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183923" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;"> levels</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> achieved before the Crash. I attribute this to the combination of sluggish money growth (~6%) and the slow recovery of the credit </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183931" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">cycle</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">. For the economy to accelerate to escape velocity will require faster money growth (9%) and much stronger housing activity. In other words, the economy has not yet recovered from the trauma of 2008. </span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">There is still substantial slack in the labor market. The participation </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183927" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">rate</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> has not recovered at all. The broad measure of </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183925" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">unemployment </span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">(U6) is at 12%, far above the 8% level before the Crash. Ten million workers have no jobs. Therefore, </span><span style="color: black; font-family: 'Times New Roman'; font-size: 19px; vertical-align: baseline; white-space: pre-wrap;">I would be very surprised if the June employment number has any effect on monetary policy. The Fed has not yet achieved full employment, nominal growth remains very slow, and capacity is not constrained. What would change the Fed’s mind would be a sustained rise in core </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183928" style="line-height: 1.15; text-decoration: none;"><span style="color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">inflation</span></a><span style="color: black; font-family: 'Times New Roman'; font-size: 19px; vertical-align: baseline; white-space: pre-wrap;">, but I don’t expect this given the economy’s weakness and the slack in the labor market. (The employment cost index grew at a 0.6% annual rate in 1Q14.) </span></div>
<b style="font-weight: normal;"><br /></b>
<br />
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Investment Conclusion</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The big drop in nominal GDP in 1Q14, and the big spike in employment in June are both noise. Nothing has changed: inflation remains low and the Fed is unlikely to tighten in the foreseeable future. For the capital market, this means that there is very little risk of an inflation spike that would cause stock and bond prices to decline. We are living in a new world of permanently slow growth and low interest rates.</span></div>
<br />Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-84050905206681237902014-07-02T12:00:00.001-07:002014-07-02T12:00:25.511-07:00The Equity Risk Premium Is Still High<ul style="margin-bottom: 0pt; margin-top: 0pt;">
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The stock market remains attractively valued.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The equity risk premium remains high by historical standards.</span></div>
</li>
<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The size of the premium reflects the low yields on offer in the bond market.</span></div>
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</ul>
<b id="docs-internal-guid-f824a6e9-f871-e542-5daa-171131f5f71b" style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">At the beginning of each month, Professor Aswath Damodaran at NYU </span><a href="http://pages.stern.nyu.edu/~adamodar/" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">publishes </span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">his estimate of the implied equity risk premium as of the first day of the month. His estimates go back to 1961. Today he published his estimate for July 1, 2014, which is 5.4%. How should we interpret this number?</span></div>
<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The 53-year range for Damodaran’s ERP is 2.0% to 7.7%, and the eyeball median is between 3% and 4%. Since the Crash, the range has been between 4.4% and 7.7% (the all-time high, set in March 2009 and again in October 2011) . The current number is the highest it has been since last October. </span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">My personal view is that when the ERP is above 4%, the stock market offers an adequate risk premium, and when it is below 4% it is less compelling and more risky. The all-time low was set in 1999 at 2.0 %. The stock market was highly overvalued at that time, and it took 15 years for the real S&P 500 index to return to its 1999 high. </span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Fernando Duarte and Carlo Rosa at the New York Fed published a </span><a href="http://newyorkfed.org/research/economists/duarte/Duarte_Rosa_EquityRiskPremium.pdf" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">paper </span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">on the ERP in January: “The Equity Risk premium: A Consensus of Models”. The authors concluded that:</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">There is broad agreement across models that the ERP has reached historical heights [as of mid-2013] even when the models are substantially different from each other and use more than one hundred different economic variables. [Note: today’s ERP is only slightly below the level in mid-2013.]</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The ERP is high at all foreseeable horizons because Treasury yields are unusually low at all maturities. In other words, the term structure of equity premia is high and flat because the term structure of interest rates is low and flat. Current and expected future dividend and earnings growth play only a minor role. </span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">A high ERP caused by low bond yields indicates that a stock market correction is likely to occur only when bond yields start to rise. </span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">We should no longer rely on traditional indicators of the ERP like the price- dividend or price-earnings ratios, which all but ignore the term structure of risk-free rates.</span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The current high levels of the ERP are unusual in that we are not currently in a recession and we have just experienced an extended period of high stock returns. During previous periods, the ERP has always decreased during periods of sustained high realized returns. It is unusual for the ERP to be at its present level in the current stage of the business cycle, especially when expectations are that it will continue to rise over the next three years. </span></div>
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<li dir="ltr" style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; list-style-type: disc; text-decoration: none; vertical-align: baseline;"><div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Our analysis provides evidence that is consistent with a bond-driven ERP: expected excess stock returns are high not because stocks are expected to have high returns, but because bond yields are exceptionally low. </span></div>
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<b style="font-weight: normal;"><br /></b>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The key take-away from their paper is that the stock market offers an attractive risk/return relationship not because of expected earnings growth, but instead because low interest rates justify a high PE ratio. A simple way to look at it is to compare the PE of the 10-year Treasury bond with that of the S&P 500. The current PE for the bond market is 40x, while the PE for the stock market is 20x--even though corporate earnings grow and bond interest doesn’t. </span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">One might argue that both stocks and bonds are overvalued, perhaps due to the zero funds rate and quantitative easing. However, I see no evidence that bond yields are artificially low. Bond yields are historically low because inflation expectations are historically low. Despite “unprecedented monetary stimulus”, both expected and observed inflation have remained low. </span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Admittedly, the bond and stock markets are vulnerable to an inflation shock, but I don’t expect one. Money </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183673" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">growth</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> remains in the mid-single digits, </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183674" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">velocity</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> continues to decline, overall credit growth is </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183675" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">modest</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">, and nominal growth is at a </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183671" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">recessionary </span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">level. Higher oil prices are deflationary, not inflationary.</span></div>
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<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">I am aware of the argument that “true” inflation is much higher than reported, but this requires a level of paranoia that is neurotic and not analytic. Inflation is low, which is why the prices of gold and silver have been falling for almost three years. Not only is price inflation low, but also </span><a href="https://research.stlouisfed.org/fred2/graph/?graph_id=183681" style="text-decoration: none;"><span style="background-color: transparent; color: #1155cc; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: underline; vertical-align: baseline; white-space: pre-wrap;">wage growth</span></a><span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"> is currently flat.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Investment Conclusion</span></div>
<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">The stock market has offered investors a historically high risk premium since the Crash. While the current premium is below the all-time highs following the Crash, it remains elevated at all horizons and does not depend upon expected earnings growth. Higher inflation and bond yields would reduce the premium, but I see the risk of an inflation shock as low. Consequently I believe that the stock market remains attractively valued at current prices.</span></div>
<br />Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0tag:blogger.com,1999:blog-7475395270631949054.post-33733109581321998432014-06-13T14:33:00.002-07:002014-06-14T11:38:07.723-07:00A Brief Note On The War In The Middle East<div dir="ltr" style="line-height: 1.15; margin-bottom: 0pt; margin-top: 0pt;">
<span style="font-family: 'Times New Roman'; font-size: 19px; line-height: 1.15; white-space: pre-wrap;">The United States is fighting a cold war with Iran. US policy has been to aid Iran’s enemies (the Gulf States, Israel) and to hurt Iran's friends (Syria, Hizbollah). So, when Sunni insurgents revolted against the Assad regime in Syria, the US provided them with covert assistance. These Sunni insurgents are the same people who are now invading western Iraq and are menacing Baghdad.</span></div>
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<span style="font-family: 'Times New Roman'; font-size: 19px; line-height: 1.15; white-space: pre-wrap;"><br /></span></div>
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<span style="font-family: 'Times New Roman'; font-size: 19px; line-height: 1.15; white-space: pre-wrap;">So now there is a regional Sunni-Shi'a war in Syria/Iraq, in which US is supporting both sides: the Sunni jihadis in Syria and the Iran-aligned Shi'a in Iraq. US policy is to bring peace to the region by providing arms and assistance to both sides in this bloody war.</span></div>
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<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;"><br /></span>
<span style="background-color: transparent; color: black; font-family: 'Times New Roman'; font-size: 19px; font-style: normal; font-variant: normal; font-weight: normal; text-decoration: none; vertical-align: baseline; white-space: pre-wrap;">Now I understand the Nobel peace prize. </span></div>
Christopher T. Mahoneyhttp://www.blogger.com/profile/07096275297545797428noreply@blogger.com0