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

Trump’s Emergency and the Wall

I presume that Trumps Emergency is strictly political theater as it will be tied up in the courts for the next couple of years.

Trump has no problem with this as he can tell his base that it is working and they will accept his story.

Now I’lljust wait and see the response to this idea.

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Stock Market Valuation

Trump is blaming the Fed for the recent poor stock market performance. For once, he may be right.

The recent market plunge took the stock market PE from the top of my fair value band through the bottom. The last observation is the 14 December close. The fitted PE has is a function of both short and long term yields.  This approach implies that the market is now cheap, but that does not necessarily mean that it is a buy.

Figure 1


Maybe you would prefer a leading indicator approach. In this case real MZM growth ( zero maturity money= M1 +money market accounts). It is obvious that MZM growth is still weakening and signalling that the market PE should contito fall. It is just the simple theory that stock market liquidity and movement are driven largely by monetary policy and right now monetary policy is tight enough to drive the market below the fair value band. Moreover, since MZM  growth is still weakening it implies that the market downdraft is not over.

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What will it take for Trump to remove a tariff ?

If Trump applies a 25% tariff on a $1.00 item the price will go to somewhere from $1.00 to $1.25.  At $1.00 domestic producers have have been building all they can to sell at $1.00.  In the short run they can not build more capacity so the domestic producer can raise their price to $1.25, or something under $1.25 if the foreign supplier can absorb part of the tariff.  In the longer run domestic producers can produce more of the item but their costs will now be over $1.00.  If they could have supplied it at under $1.00 they already would have been. Before they invest the capital to generate more capacity they will need some assurance that the tariff will not be removed and the import price will not go back to $1.00 making their new capacity unprofitable.  Does anyone, including Trump, have any idea how this end game will play out?  Or, will we just see a 25% increase in the price and no change in the domestic and foreigner market share.  In other words, why wouldn’t  a new tariff just lead to higher prices and lower demand  with no other changes?

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June real trade balance

When the second quarter real GDP report was published I saw that trade made a major contribution to growth — exports contributed 1.12 percentage points of the 4.1% real GDP growth.  But that seemed like some sort of fluke produced by unusual conditions rather that what trend growth would generate.  Moreover, the BEA estimate was based on only two months actual data and the other month was a BEA “guesstimates”.  So new data was quite likely to generate large changes in reported real  GDP. June data was released this morning at the same time as the unemployment report, so it did not get much attention. Real exports increased and real imports imports declined. Both moved back toward their intermediate growth trend.

The trade balance is the difference between two very large numbers so that small changes in either series can generate very large changes in the trade balance.  The June real trade deficit was $ 7.9 ( B 2012 $ ) as compared to $7.7 ( B 2012$)  in April and  $7.5 ( B 2012 $) in May. The June trade balance is about where is was at the end of the first quarter.  So when the 2nd quarter real GDP is revised the major contribution from trade is likely to be revised down significantly.

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Revised real GDP growth

Along with the second quarter GDP report the BEA also published the results of its regular revision of the last five years of data.  The most significant revision was to the measure of price changes in the high tech arena. This showed that business investment had been somewhat stronger than previously reported, but it only had a very minor impact on real GDP growth.

The chart shows the year-over-year growth in real GDP over the 2012 to 2017 period with the revised data.  I doubt if you will see this data published by the Republicans.

Revised YOY Growth 2012 to 2017

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In a low inflation world firms tend to raise prices once a year — typically in the first quarter or the first quarter of their fiscal year. Consequently, over half of the annual increase in the not seasonally adjusted core CPI occurs in the first quarter and doubling the first quarter increase gives an amazingly accurate estimate of the annual rise in the core CPI.

Figure 1

This year the first quarter rise in the not seasonally adjusted core CPI was 1.2% as compared to 0.9% in 2017. This implies the core CPI will be up 2.4% in 2018 versus 1.8% last year. This would be the largest annual increase in the core CPI in a decade.

Figure 2

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Trump’s job creation record

Trump and his administration love to brag about the number of jobs created since he became president.  But the only reason he gets away with claiming that a record number of jobs have been created since he took office is the poor job the press does reporting economic data. It only takes a quick glance at the data to see that job creation under Trump has been essentially identical to Obama’s record during the expansion phase of this cycle.  Excluding the Great Recession and the bounce back from it assures that the comparisons of the two presidents record are of what happened in the expansion phase of the cycle. So both records is of job creation under essentially identical economic environments.


Figure 1

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Import and export growth and an expanding trade deficit do not need a strong dollar.

Import and export growth and an expanding trade deficit do not need a strong dollar.

We have had some discussions about dollar weakness and questions for those of us who expected the federal deficit to lead to a larger current account deficit through a strong dollar.

I’ve looked at the data in a different way and now wonder if we really need a change in the dollar to achieve a larger current account deficit.   If you look at real imports and exports you see that real imports are now 155% of real exports and the basic trend is for imports to grow much faster than exports.  Since 2013, real import growth has averaged some 3.4% annually while real exports only grew at about a 1.5% annual rate. If you project these trends out it implies that the real trade deficit would expand about 6% annually, or about a half a percentage point per month.

Interestingly, over the past year or so non-petroleum import prices have grown some 1% to 2% annually, or about the same  rate as domestic prices. So  there has been no significant changes in import prices relative to domestic prices.

So at least from this perspective I would expect  imports market penetration to continue expanding.   After all, in the overall trade balance, steel and aluminum tariffs — especially with major exceptions, like Canada — are not large enough to make much difference.

Figure 1

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Stocks have gone from overvalued to fairly valued.

With the market falling like it did over the past week it may prove valuable to look at the PE and some other economic reports.  In my PE model the market became overvalued in December and January.  The last observation is at the market close on Thursday, 8 February 2018. the previous two observation are the end of December and January values.

Notice that the PE did not rise until December . As of November, 2017 the market PE was still below where it was when Trump was elected.  If the market rallied because investors expected higher future earnings because of the tax cut, it did not show up in the PE until the tax bill was actually passed.  The usual rule is to buy the rumor and sell the fact.  But given Trumps record, it was understandable that investors were not willing to pay up for stronger earnings until the legislation was actually signed into law.

Most of the market rally for a year after Trump was elected reflected double digit earnings growth rather than  a higher PE as investors started discounting stronger earnings.  Now, we have a divergence in earnings expectations as the top down strategists and economist expect the tax cut to generate double digit earnings growth in 2018.   But the bottoms-up analysts only expect modest earnings gains. Analysts expectations are driven largely by company guidance. This divergence may suggest that corporate America is not as bullish as Wall Street has been the last few months.

Generally ignored because of the jobs report,  productivity was reported the same day as unemployment, and it was very weak.  As a consequence, the spread between unit labor cost and prices — the nonfarm deflator– narrowed sharply. This spread is the dominate determine of profit margins and is a leading to concurrent  indicator of earnings growth. It implies that earnings growth will be quite weak over the next few months.  Right now there seems to be two views on 2018 profits growth.  Economists and strategist expect the tax cut to lead to double digit earnings growth in 2018 while  analysts expect single digit earnings growth.  Analysts bottoms-up forecast are driven largely by management guidance.  So this divergence between analyst and economists may imply that corporate management may not be as bullish on the economy as Wall Street.

Moreover,my bond model implies that bond yields should be rising.  Rising rates are especially hard on the market when the market is overvalued. So you are faced with an market where rates are rising and earnings expectation are falling.

Finally, the dollar is weak despite the point that interest rate spreads between US and foreign rates are rising. Historically, the combination of rising interest rate spread and a falling dollar is a very bearish development.

The bottom line is that this market fall is being  produced in Washington. Over the last six years under Obama we had a combination of easy money and tight fiscal policy as the Republican Congress implemented restrictive fiscal policy– the deficit fell from near 10% of GDP to about 3%. –and the Fed offset it with  easy money.  But now, Congress is implementing easy fiscal policy when the economy is at or near full employment and the Fed is being  forced to offset it with tight money policy.  The agreement to give the Republicans the expanded military spending and the Democrats the expanded social spending they want is a repeat of the guns and butter policy under President Johnson. But now, the US is dependent on foreign capital inflows to  finance the deficit and the weak dollar implies that the foreign capital is not forthcoming at current interest rate spread.

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