Relevant and even prescient commentary on news, politics and the economy.

Quality Spreads

While the yield curve turning negative is getting a lot of attention and seems to be the main excuse for yesterdays stock market drop, there are other financial indicators that are also signaling weaker economic growth ahead.

The primary one is quality spreads as the yield on corporate bonds are rising relative to treasuries.  This is driven by investors fear that in a weak economy, recession environment the risk of corporate defaults rises and bond buyers demand a larger premium to take that larger risk.It is easy to see that quality spreads are driven largely by economic weakness by comparing them to capacity utilization.

 

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Long Treasuries vs The Long Wave

Since the early 1990s, I published this chart every month on the back cover of my publication until I retired a couple of years ago.  I thought it was a great piece of marketing to remind readers that I was a long run bull on interest rates.

Readers might not pay much attention or remember claims that I was bullish, but they would pay attention to and remember this.  I even had bond managers walk out over this chart in the middle of my presentation.

Now just felt like a good time to publish it again.

Click on image to enlarge it for better viewing.

 

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The Federal Deficit by Presidential Terms

Under Trump the federal deficit has rebounded to some 4.4 % of GDP  — it is the same whether you look at it quarterly or monthly data as this chart does.  The monthly estimate is calculated by Haver Analytics. So much for the tax cut paying for itself.

 

The shaded areas are by Presidential term, not of recessions as is usually the case.  Typically, Republicans leave office with a larger deficit than they inherited while Democrats leave with a smaller one, or a surplus. Of course, this is exactly what “starve the beast” calls for.

Federal Deficit each Presidential Term

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THE EPIC JOURNEY OF APOLLO ELEVEN

This is my oldest son the weekend of the Apollo moon landing.

The whole country was glued to their TVs that week.

Figure 1

The TV was about the state of the art 50 years ago and my brother, the photo journalist, took the photo.  In  the pre-digital era he mostly worked in black and white.

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S&P 500 P/E

Friday evening the S&P 500 closed at 3013.77, up 20.2 % year to date. But much of that gain is just recovering from the drop in late 2019, as  it is only up some 3.4% from September, 2019.

This is the first time the S&P closed above 3000 and people are wondering if the market is overvalued. The S&P 500 PE is now at 19.6, almost exactly where my model implies it should be.  As the chart shows it is right in the middle of my estimated fair value band just as it was when Trump was elected.  But the PE was 21.3 in November, 2017 as compared to 19.6 now. Both the actual PE and the fair value band declined through 2017  and 2018 and the fair value band has stabilized so far this year.  Interestingly, this means that S&P EPS has been rising faster than the market since Trump was elected. So, aside from the tax cut, investors are not projecting that his economic policies will generate stronger earnings growth.

Figure one

But my model PE is strictly a function of interest rates.  It is an expression of what is the present value of a perpetual stream of earnings growth. You can see how the model said the market was very expensive in the 1990s when investors came to believe that we were in a new era of stronger growth  with out a significant  risk of recession. The early 2000s were just the opposite, when investors feared we were in a new era of permanent stagnation and very weak earnings growth. So the PE was very far below its fair value.

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LONG BOND YIELDS

Everybody and their brother has an opinion about the direction of long bond yields so  it should be OK for me to stick my two cents worth in.

This chart of the composite of all long bond yields versus the long wave is one I published every month on the back cover of my monthly publication for over 20 years before I retired a couple of years ago.  Basically, I thought of it as a good way  to show that I was a long term bull on interest rates in a way that money managers would remember. But it did get their attention. The basic message was that on the up-sweep of the long wave, bear market were long and deep while on the down-sweep, bear markets were short and shallow while  bull markets were long and deep.

Figure one

Of course it is always nice to have some basic data to support such a chart and the economic data that seemed to have the best fit over the long run was MZM ( zero maturity money) velocity —

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Real Per Capita Income by State ( 2012 $ ) Updated

You can not use inflation data like the CPI to compare living cost is one location to another.  So the BEA has constructed a database  of Regional Price Parities  ( RPP) that allow you do do that for all states and the some 383 Standard Metropolitan Areas in the USA. I was preparing to show them when BEA published the 2018 data.  But that data will not be released until next year so I’m going ahead and showing the 2008 to 2017 data. Note, that in the tables for real per capita personal income by state for 2012 and 2017,  I have converted the data in 2012 $ to an index of personal income as a percent of the national average to facilitate comparisons.

Figure one

The first thing I noticed in the data is Connecticut and Massachusetts  at the top of the tables with per capita real incomes of 129.6% and 121.6% of the national average, respectively.

Even adjusted for the high cost of living they still have the highest real per capita income in the US.  I’ve long  thought of these two states as prime examples of the post-industrial economy.They were the first industrial states and  went through major problems when the textile and shoe industries departed for cheap labor in the south — something quite like the rust-belt states are now experiencing. But that was decades ago and they have now developed economies based on education, finance, high technology and medical care.  The basis for each was  the state investing strongly in education throughout the decline of the old industries so that they had the trained labor force to take advantage of new opportunities.

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