U.S. ECONOMY AT A STANDSTILL IN Q1, AND LIKELY TO TRUDGE ALONG INDEFINITELY AT NO MORE THAN 2% GROWTH

The initial estimate of first quarter GDP shows the economy at a standstill but the Fed, markets and most economists are still brimming with optimism about what lies ahead for the rest of the year. Today’s release showing a 0.1% gain in GDP over the first quarter of 2013 as compared to the disappointing 2.6% gain in the fourth quarter is largely being dismissed as a “wacky” number, with commentators quick to remind how bad the winter was. The bad weather excuse, however, has about as much credibility as “the dog ate my homework”. There are numerous reasons to doubt that the rest of the year will be as good as is being assumed, starting with the miserable record of forecasting that we saw last year from the Fed and economists, and ending with the lackluster earnings reports and persistently weak tone of the forward guidance we have been getting from companies in recent days. These corporate results have analysts busy trimming their Q2 estimates after already having slashed those for Q1.

And while the U.S. equity market as a whole has remained buoyant, probably for lack of any better investment alternatives, money managers have been fleeing anything that appears to be the least bit risky adopting a defensive posture that suggests they are not all that enthusiastic about economic prospects.

The gap between what appears to be the economic reality of sluggish growth at about a 2% to 2 ¼% annual pace for as far as the eye can see, and the average economist projection of 2.7% for 2014 as a whole, which means well in excess of 3% in the second half, is as wide as anytime in recent memory. Most disconcerting, is a feeling that the Fed is so hell bent to be done with QE by the end of the year that they are becoming cheerleaders for the economy, feeding us such happy talk as “growth has picked up recently” and “household spending appears to be rising more quickly.”   

It is true that consumers were the brightest spot in the otherwise uniformly somber Q1 picture as they braved the snow to push their inflation-adjusted spending up 3.0%, almost as good as Q4’s 3.3%, helped in large part by an acceleration in government social welfare benefits and a drop in tax payments. But when we look closely at the increase in personal consumption expenditures we see that the largest part consisted of utility bills and Obamacare sign ups, and they had to trim their saving rate back a bit to do that much. The only other reason that the GDP estimate was not negative in Q1 is that the federal government managed to increase its spending by 0.7%, mainly in the Defense Dept., after the sequester chopped spending by 12.8% in Q4.

Housing was the biggest worry in Q1, because the anticipated vigorous recovery of housing construction after the Spring thaw is at the core of much of the optimism about the 2014 outlook. Although housing looked set to take off last Spring, sales and new construction stumbled last year as mortgage rates moved up from record lows. Data that has surfaced in recent weeks suggest that it will take more than the start of the Spring home-buying season to get the market moving again.

Sales of both new and existing homes look set to stay at relatively low levels in the near term. The difficulty that buyers are having qualifying for credit under the much higher standards now in effect seems to be the greatest problem, but rising building costs and higher home prices are also bringing affordability into question. The big shock came when new-home sales fell 14.5 percent in March, while at the same time sales of expensive homes with jumbo mortgages (over about $650,000) rose by 7.8% and the first sale of an individual residence for over $200 million was recorded.
 

Meanwhile the ISM and Markit purchasing manager surveys for April that give perhaps the best overall reading of how the economy is shaping up, indicate that the US economy while stepping up from the January and February weather influenced lows, is not exactly entering the 2nd quarter with a full head of steam. Mostly, they show an economy trudging along at a monotonously steady annual pace of about 2%, with the jobs market showing little or no significant signs of improvement. The Markit surveys that are relatively new even point to non-farm payroll growth sliding to around 100,000 per month in sharp contrast to expectations that Friday’s April jobs report will top 200,000. In the services sector that encompasses about 80% of the economy, there are worrying signs for future momentum. Levels of outstanding business fell, and firms’ optimism about the year ahead have also waned in sharp contrast to the views of most economists and important policymakers as well.

After the earnings season ends in a couple of weeks and markets finish digesting the results, all eyes will turn to the economic outlook for the rest of the year. Ukraine has largely been dismissed as a slow motion event with both Europe and the U.S. careful not to impose the kind of sanctions that could rock the global economy. If the economic outlook disappoints, as seems likely, we could see more of the same risk aversion by money managers, with a lot of choppy market action, more sideways than upward moving, but not necessarily precluding the market from continuing to grind slowly upward in a relatively calm if not exuberant atmosphere, with 10 year Treasury yields remaining under 3%, and more and more discussion of how the Fed will ever be able to raise interest rates to so-called.”normal” levels.

Battle of the Billionaires

With the U.S. and other members of the G-7 targeting Putin's inner circle of billionaires to gain leverage over Russia's actions, we may be seeing what warfare in the 21st Century will look like. Information technology and an economically inter-connected world have made us more confident than even a decade ago that we now have the means to identify the most powerful oligarchs, where their wealth resides, and the buttons to push that can cripple their businesses and cause them financial distress. As nation states become dominated by a small number of super billionaires, this may become the primary means of engaging in conflict and resolving disputes.

This is an area, incidentally, where Karl Marx's "Das Kapital" and Piketty's "Le Capital" saw different outcomes. Whereas Piketty sees extreme inequality of wealth being eventually overcome by social pressures and political forces that take control of capital via taxation and democratization of ownership, Marx saw the ultimate solution in imperialistic regimes, warfare and violent revolution. Piketty sees little likelihood that the return on capital will decline very much in the years ahead, while Marx saw the increased supply of capital steadily reducing the rate of return towards zero, resulting in cut-throat competition that would bring nation states to use armed force to control markets and vie for territorial expansion.

POPULAR BLOGGER "THE FLY" GIVES UP ON THE MARKET

Although the S&P500 is still within 2% of its all-time high, an awful lot of damage has been done beneath the surface. After grinding higher for 7 of the last 8 days and coming within a hair's breadth of the all-time high, the market took a nasty dip again on Friday confirming that the current market correction is not over. The Business Insider article linked below describes how a popular stock market blogger who calls himself "The Fly" was obliterated by this market and finally threw in the towel on Friday. It illustrates how the popular "buy the dips" strategy, or prematurely guessing that a bottom has been reached, often results in the most devastating losses, and why it is so important to rigorously cut any and all losses at a predetermined limit.

What that limit should be depends on market conditions and your recent won-loss record. In a choppy market where you are having a hard time keeping your won-loss record above .500, you should probably aim to harvest most of your wins at 10% to 15%, sometimes even less, while cutting losses at 4% to 6%. In a better market where your win-loss percentage is .600 or better, you can aim to harvest gains of 15% to 20% while limiting losses at 6% to 8%. In other words, aim for a 2.5:1 ratio of gains to losses.

This does not mean that you should sell everything at the upper limit. Truly strong stocks can be held for much larger gains, but recognizing that such stellar performers do not come around that often, and since even the best usually pause to catch their breath after a run of 20% to 25%, it’s a good idea to take some money off the table by selling at least a small part at that point. You can often get back into these stocks with a larger holding when they take off again after a rest, while redeploying the proceeds into better performers while they consolidate.

Before you rush off to buy anything, remember that the market is currently in a correction so nothing should be bought until a new uptrend is confirmed. You won’t catch the exact bottom, but you will be much better off waiting patiently for the all clear signal rather than rushing in prematurely and being crushed by a dip like last Friday’s or worse.

http://www.businessinsider.com/the-fly-out-2014-4

RISKS IN THE CURRENT MARKE CORRECTION, BUY ON STRENGTH NOT WEAKNESS

Friday, April 25, 2014

Market corrections are dangerous. It’s easy enough to step aside as the market drops but more difficult to avoid the temptation of jumping back in too early before the correction has run its course. Every correction is interspersed with rallies, sometimes quite impressive rallies that can lure us back in prematurely with so-called "head fakes". More money is probably lost from the temptation to buy cheap at the very bottom of the decline, and from the anxiety of missing out on the rebound, than from the decline itself.The most common mistake that traders make is to buy stocks on weakness, because they are cheap. Such action says that you know more than the market does, which is rarely true. The market has a way of humbling those whose egos tell them they are smarter than others. What is cheap is cheap for a reason. It may be a bad reason, a stupid reason, a reason we disagree with, but there is a reason. And what is cheap can get cheaper, much cheaper!A better strategy is to buy on strength, but only after the market as a whole has moved from the current correction phase into a confirmed uptrend. Even the strongest stocks will have difficulty swimming upstream against a market correction. And it takes more than a day or two’s rally to end a correction. There must be signs of institutional investors coming back into growth stocks with conviction. Markets don’t get very far on the strength of stodgy defensive stocks. They need the excitement of the newer and smaller high growth potential stocks. And we need to see a pattern of prices increasing on higher volume and declining on low volume as opposed to what we now have which is the opposite.But even after the caution flag is lifted and the market is in a confirmed uptrend, one must be careful not to chase after stocks that have bolted out of the gate and moved up so far as to become over-extended. Extended stocks will at some point pull back, and the more extended they are the sharper the pull backs will be. When a stock is extended the risk of a sharp pull back overrides the potential for gain.Successful trading requires careful study of the daily price and volume action to determine the timing and price level at which the risk/reward ratio is most favorable, and that means the point at which the stock is breaking out of a consolidation pattern with sufficient strength, big volume buying interest, to carry it upward to a new plateau. Buying too early and in the absence of sufficient buying interest or volume risks a breakout that will fail and plunge lower as disappointed buyers and holders that were looking to sell take advantage of the aborted move to dump their shares. Buying too late after the horse is out of the barn and has already galloped too far away risks being caught in the inevitable pull back.Trading is basically a game of chance. The odds are stacked against you because every human emotion impels you to make the wrong move out of either fear or greed. Careful study and dispassionate action can tilt the odds slightly in your favor. You will still be wrong about half the time, but if you have tweaked the odds slightly in your favor when taking a position --- and most important, have disciplined yourself to take losses dispassionately, relentlessly confining them to a targeted level --- it is possible to keep the average gain ahead of the average loss on a fairly consistent basis.

Permanent Secular Stagnation?

ARE THE WORLD’S ADVANCED ECONOMIES LOCKED INTO A PERMANENT STATE OF SECULAR STAGNATION?

SUGGESTING FOR THE U.S. CONTINUED SLOW GROWTH, HIGH UNEMPLOYMENT AND A FALLING STANDARD OF LIVING FOR THE 90%, MAKING IT IMPOSSIBLE FOR THE FED TO WITHDRAW MONETARY STIMULUS AND “NORMALIZE” INTEREST RATES.

The disturbing idea of “secular stagnation” was first raised by Harvard’s Alvin Hansen, in his 1938 presidential address to the American Economic Association, at a time when the Great Depression was stubbornly dragging on. Hansen suggested that the high unemployment of that time might continue for many years as the permanent condition of the economy. He attributed his “secular stagnation” hypothesis to a decline in the birth rate and an over-supply of saving by the aging population. The excess saving meant that there was too little aggregate demand to spur investment, production and employment, and thus no natural forces to return the economy to full employment.

Shortly afterwards there was a huge increase in government spending as America began to prepare for war, and after the war a “baby boom” that increased the population, the economy prospered and economists forgot about the problem. After 1995 the mild deflation of the Japanese economy stirred interest in the question of secular stagnation again, but that was attributed to Japan's rapidly aging population and other special circumstances of that economy. Now, however, the persistent slow growth and high unemployment of the U.S. and Europe five years after the Great Recession is bringing the question to the forefront once more.

Only last year, Larry Summers wrote an article for the Financial Times titled, “Why Stagnation Might Prove to be the New Normal.” In the article Summers suggested that the crisis of 2008 may have ushered in an era of “secular stagnation” in much the same way as Alvin Hansen had described in 1938. He suggested it might even have started sooner only to be hidden by the housing bubble. Numerous others picked up on the theme in a flurry of commentary, including Krugman, Taylor and DeLong, but no one had presented it in the form of a substantive theoretical model until Gauti Eggertsson of Brown Univ. and Neil Mehrotra of Columbia Univ. took a first stab at it in the linked paper released 11 days ago. The model constructed by Eggertsson and Mehrortra shows that a condition of permanent secular stagnation is possible as a result of a deleveraging shock brought about by a financial crisis in combination with slowing population growth and/or increasing inequality.

More importantly, the model shows that:

1. Absent a higher inflation target, the zero-bound interest rate policy of the Fed will be locked in place permanently because output will remain below the full employment rate and any increase in interest rates would further depress the economy.

2. With zero being essentially the lower bound for nominal interest rates, it would be impossible under conditions of secular stagnation for Fed monetary policy alone to achieve full employment and reach potential growth.

3. Under these conditions, full employment and maximum growth would require a continuous increase in debt financed government spending.

The authors have promised further consideration of the fiscal policy implications in a future elaboration of their model, as well as a consideration of the impact on asset prices which they believe will also be important.

It seems clear that we cannot sit idly back and expect the Fed and natural forces to “normalize” the situation and restore growth with full employment on their own. Fiscal policy will have to come into play. It may also be naive to expect that the Fed will be able to withdraw monetary stimulus and “normalize” interest rates anytime in the foreseeable future, not in 6 months after the end of QE, nor one year later, nor ever, without a new QE that targets inflation of at least 4%, if not higher, and/or a radical change in thinking about government spending and the national debt.



Link to: "A Model of Secular Stagnation"
http://www.econ.brown.edu/fac/Gauti_Eggertsson/papers/Eggertsson_Mehrotra.pdf