We're Dancing - Until the Music Stops

We can dance if we want to
We can leave your friends behind
Cause your friends don't dance
And if they don't dance
Well they're no friends of mine

There have been several recent articles complaining that the economy is not “in sync” with the stock market.  Of course these articles are rubbish and not worth even skimming.

The economy and the stock market are like a pair of flamenco dancers.  The man (the economy) usually takes the lead and the woman (the stock market) usually follows. But the woman can also lead, as the man watches admiringly.  At times (let’s say when the economy is very strong or very weak) the man and woman dance very close and in unison.  However there are many times when the dancers are physically distant and even though they share the same floor and music, the dances are not the same.

Let’s pretend our flamenco dancers were performing on a ship that encountered some horrific waves (the Great Recession).  The man was thrown off the floor to the right and injured his leg.  The woman was thrown off the floor to the left and broke a heel.  While the music continued to play, the man struggled to regain his bearings and limped back to the dance floor.  As he did, the woman repaired her shoe and still dazed, tried to resume the dance.  This dance is not going to appear very graceful for a long time.

I have written before about how many reliable economic indicators are still out of sync. So why would you would expect the economy and stock market to be more coordinated now? 

Yes, in the long run and in the big picture, the two have to be well connected, but at many times the correlation suffers.  If it didn’t, it would be much easier to predict the stock market.   The economy is basically the economy, but there is a big emotional and psychological aspect to the stock market.  Sometimes she dances as expected and other times she has a mind of her own.  But she is so sexy when she dances, that investors cannot resist her.  She creates such passion in her followers.  She rises, she swoons, she is memorizing.

The other strange thing about the articles is that you could argue the economy and stock market were actually dancing close together in Q1.   The economy grew 2.7 percentage points more than the previous quarter. (3.1% estimate Q1 minus 0.4% in Q4) and the stock market was on fire.  Of course the problem with this is Q1 is still just at 3.1% GDP and this is expected to be the strongest quarter of the year. 

And the employment report for March was just dog awful.  When almost a half million people are so discouraged they quit even looking for work, your job market reeks.  I’m so glad our government is laser focused on the economy and job market instead of spending time working on peripheral issues.

The latest Wall Street Journal Economists Survey GDP (total survey average):

Q1 = 3.1%

Q2 = 1.8%

Q3 = 2.4%

Q4 = 2.7%

If you would forecast the stock market from this data, the market would continue to increase at a slow to moderate rate the rest of the year.  However, virtually no one is predicting this scenario.  The two most common forecasts fall in one of two categories:

1.     The market is way undervalued.  The market will continue to go up, up, up, in anticipation of the economy growing even stronger.  Some proponents of this theory predict the market is about to explode into the stratosphere.

2.    The market is way overvalued.  The stocks have risen in anticipation of a stronger economy which hasn’t materialized.  Banks are weak, Europe’s weak and Obamacare is going to kill the recovery.  Some people on this side are not predicting a correction but a huge crash.

So that makes it very clear what to do, right?

Model T Update

The Model T prediction of an S&P peak of 1550 was surpassed on March 11 when it closed at 1556.  The plus 2% upper limit of 1583 was breached with a 1587 close on April 10.   This means the Model T was not able to predict the market peak within a 2% range this year. It does seem like the market is currently bouncing around in this range, which would indicate that we are near the top.

However the value of the market peak is not as important as the timing of this peak, and the Model T is still predicting a peak in the May/June period.  If the market is peaking in May, you would expect it to be humming in April.  I didn’t explicitly state this in my January (Sell your Stocks in May?) post , but of course it was implied. If you are not selling until May, you still expect to be making money in April!

Next Post: It’s Put Up Or Shut Up Time!

Diversifying Into Crap

Background: I manage what I call the GeoDon Fund, a portfolio of stocks that my grandfather George put together a long, long, time ago.  I inherited a portion of the “fund” from my mother in 2010.  The portfolio had been basically untouched for over 35 years and I have attempted to clean up, diversify and “modernize” the holdings based on the original investing principles George followed.

Scene: It’s Saturday morning and I’m reviewing the GeoDon Fund on my computer, when the ghost of George suddenly appears.

Don: George! What are you doing here?

George: I see you are reviewing our fund and I wanted to see how you are doing.

Don: The fund is going very well.  Look at these winners!

George: Are you following my rules?

Don: Of course I am.  Look at how I have diversified the fund and spread the risk.

George:  What about these stocks?

Don: Ah, these three were not good choices, but I diversified and didn’t put much money in any of them.

George: Diversification doesn’t work very well if you diversify into crap.  You just get three flavors of crap instead of one. And this dog, what does this company do?

Don: This is a commodity company.

George: Commodities?  That’s risky business, my boy. This doesn’t fit with the rest of the portfolio.

Don: I know it’s not exactly a blue chip, but it had potential.

George: No it’s not a blue chip. In fact it looks more like a cow chip! Why on earth did you buy stock in this company?

Don: Well it had a high dividend with significant growth potential.  It was a no brainer.

George: I can see how someone with no brain would buy this stock.  Son, chasing this type of stock is like chasing skirts; you may have some fun for a while but it never ends well.

Don: Hey, it’s not my fault!  The company lied and said the dividend was very safe and future sales looked strong.

George: Unfortunately it is totally your fault for believing that garbage.  That’s why you stick with the blue chips and quality firms.  Those companies have established integrity over time.  Why did the stock drop so fast?

Don: The company cut the dividend by 76% and then announced earnings were weak and would get worse.  All the big mutual funds dumped their holdings and the stock tanked.  I read that when a company deceives the market, mutual funds dump it because they can never trust the company again.

George: So did you do your own research on this company?

Don: No, we have this great thing called the Internet.  On the Internet, all these investment gurus said the stock was great, so I bought it.

George: Did any of these so called “experts” actually buy any of this stock?

Don: I don’t know.  I’m not sure that they are allowed to.

George: So these guys are not suffering a bit over this and you are left holding …..

Don:  A turd. The GeoDon Fund now has a turd.

George: How many turds?

My cat makes investments too!

Don: Three turds, I made the same mistake with three different companies. They all lied and I bought their stock.  The good news is that have some capital losses as a tax write off!

George:  Oh that’s nice.  I never had any capital loses to write off when I managed the fund.  So what have you learned from this experience?

Don: Don’t worry George, I have learned my lesson.  I am going to stick to the original principles of investing in strong, established, manufacturing firms with an emphasis in the healthcare, energy and transportation sectors.

George: That’s my boy.  Uh, what did this “lesson” cost you?

Unfortunately, you can't polish a turd

Don: The three turds are down about $6,500.

George: The classes in this school are very expensive, aren’t they?

Don: Yes, they are.  That’s why it won’t happen again soon.  I am going to stick to the original strategy for the fund and only buy stocks that fit with this philosophy.

(And with this George departs, his mission accomplished, for now)

We’re Buying Stocks Like It’s 2007

Streaking!

A headline in my Saturday paper said the Dow Jones just wrapped up its best streak in almost 17 years.  The recent 10 straight days of gains was the longest “winning streak” since 1997.  But remember the stock market is not a basketball team.  Basketball teams achieve winning streaks by playing well, the stock market has winning streaks because the fans decide that it’s time to keep cheering.  

Yes, this market is smoking hot!  Articles are speculating about just how high the market could go.  Other articles are encouraging investors to get back in the market big time.  Hot actresses with absolutely no knowledge of the market are talking about buying stocks in interviews.

But there have also been several articles comparing the exuberance about the stock market now to the excitement in the summer of 2007.  The market was also sizzling then.  Everybody was talking about and buying stocks.  There was speculation about how high the market could go. There was extreme investor confidence.  There was absolutely no way this market could fail.

When I instructed my broker in October 2007 to pull my money out of the market, he thought I was crazy.  This was the most contentious conversation that I have had with him in nearly 30 years of the relationship. That’s how hot the market was in October 2007, about two weeks before the crash started.

The stock market can break your heart!

The stock market is as stable as a high school romance.  It can catch fire and burn hot quickly without warning.  He/she loves me and this is going to last forever, that’s until it suddenly collapses leaving you devastated with a broken heart.

Is it Possible 2012 GDP Was Overstated?

The economy grew 2.2% in 2012, or did it?  ECRI (Economic Cycle Research Institute) says its recession forecast in 2012 is correct because when the 2012 GDP numbers are revised, it will show that we were really in recession for part of the year.

Is this possible?  I believe that the economy was so “jumbled” by the Great Recession that many of the usually reliable economic indicators are still giving off false readings.  This includes both the ECRI index and the GDP numbers.  However, if you look at some economic statistics; imports, exports, miles driven, freight, employment, it looks like growth was between 0-1% for the year. 

The two sectors that were strong in 2012 were housing and natural gas.  Housing was growing because its recovery did not start until Q1, 2012.  Natural gas production growth is due to technological innovation (fracking), not an economic cycle recovery.  Even if the economy grew at 2%, if you subtract out housing and natural gas, then the rest of the economy was very tepid.  That’s why many commentators say it still feels like a recession.  You also have to trust that the government accurately estimated GDP with no upward bias in an election year.  I have vowed not be political this year, so you must decide this one on your own.

Economic Growth Has Started (Again)

The economic reports for February have been very positive.  After a few months of 0% growth, the economy is looking much better.  My “expert” panel has raised the Q1, GDP forecast to 2.2%.  However growth will remain “choppy” with the forecast at only 1.6% for Q2.  The recent positive economic news has helped fuel the rise of the stock market and the hope of even higher gains.  However, the stock market has not been in sync with the economy for several months and a 1.6% growth in Q2 is not a positive sign.

Model T Update

The market exceeded the Model T forecast (as was pointed out by several alert readers) of 1550 on March 8.  I have been asked if the Model T needed to be recalculated.  Historically the model varies by +/- 2%, so the upper limit is 1583.  In addition, the timing of the model is more important than the S&P number.  The number is useful in determining if the model is functioning properly.  The model still forecasts a peak in May, however the fact that we are over 1550 (the peak so far in this cycle is 1563) means the peak could come in April.  I am planning to move a significant part of my money out of the market in early May.  Stay tuned.

Gamblers, Waiters and Strippers – Keys to the Recovery?

No Chance of a Recession Now?

The revised Q4 GDP came in at +0.1% (up from -0.1%) which means we are no longer in danger of going into recession! Booyah!  It also means that my December prediction of “near 0%” is still smoking hot, even if the economy is not.

Budget Cuts (or really just a decrease in the rate of growth)

The economy is still struggling in 2013 partially due to the ending of the 2% Social Security tax cut.  With your taxes 2% higher this year and gas prices on the rise, you now have between 2-3% less to spend.  So if government spending were reduced by, let’s just pick a number, say 2.4%, you would expect politicians and government officials to just tighten their belts like we are all doing without whining, complaining or threats.  For the past couple weeks it has sounded like you are taking candy bars away from six year olds.  These people are addicted to spending your money and the power that comes with it!

We are adjusting our household budgets because we have 2-3% less and the government should have to do the same.  Oh wait, I forgot.  The U.S. Senate doesn’t have a budget.  They haven’t had one for four years.  This means that every payday you send your taxes to someone who doesn’t have a budget.  They just grab the money and spend it! And when they don’t have enough money, they borrow more.

What About Now?

How is the economy doing in Q1, 2013? Let’s look at a few “different” economic indicators.

Non-Tradition Consumer Spending Economic Indicators:

Coupon Index - People are trying to stretch their money by using more coupons.  This is logical but according to the Internet Coupon Index (from Coupon.com), coupon usage has spiked just as it did right before the Great Recession began in December 2007.  Not a good sign.  Indicator: Negative

Restaurant Performance Index – This was actually up in January after four months of decline.  This is surprising since many restaurant related stocks are not doing well.  In my locale, the restaurants that survived the recession are busy but new restaurants are not opening.  This means capacity is still less than the 2008 level.  Indicator: Negative but improving.

Retail Advertising – I have noticed a reduction in Sunday sales flyers, coupon magazine thickness and junk mail in 2013.  Retailers are cutting back on spending and so are their customers. Indicator: Negative

Charitable Contributions – These are reportedly down, but it should be expected that people would cut spending here first.  However, it will be a very positive sign when giving increases.  Indicator: Neutral

Gambling – The new Ohio casinos are reporting that revenue is considerably under forecast.  But all the factors listed above for charitable contributions apply here.  Indicator: Neutral

Some Unusual Economic Indicators:

The Hot Waitress Index – This indicator says that the waitresses are more attractive during economic downturns since these women turn to restaurant jobs when they cannot find jobs in other fields.  I have previously stated that this indicator (if accurate) is only relevant in New York, Los Angeles or other big cities with entertainment industries.

However, I have noticed that there are more guys working as waiters than normal.  This is probably the result of the lack of factory and other higher-paying industrial jobs that would be more attractive to this demographic.  If this is true, as the job market improves, the ratio of waitresses to waiters should increase. Indicator: Negative

The Stripper Index – This indicator says that “gentlemen club” spending is one of the first cuts made in an economic downturn.  Reportedly more clubs are closing than opening around the country.  Conversely in Canada, where economic conditions are much better, clubs are having problems recruiting enough “entertainers”.  The obvious solution would be to export U.S. strippers to Canada.  I don’t think this will happen because President Obama says there is a shortage of meat inspectors in the U.S. due to the recent spending cuts.  And you know how picky Canada is about imported beef.  Indicator: Negative

Bottom Line: The Q1 GDP forecast of 1.2% still appears to be solid.

Model T Update:

The S&P 500 Index is at 1518, 2% below the Model T peak prediction of 1550.  Because the Model T’s track record has been between +/- 2%, the high of 1530 in February may well have been the peak.  Unfortunately the Model T does not take into account sequestrations or a possible government shutdown in April.

A possible scenario would be that another budget compromise in March results in stock market gains in April and May.  This could boost the S&P to 1550 or more and would then set the stage for a major correction.

Who Can Afford the Affordable Healthcare Act?

Recently I visited a church I hadn’t been to for years.  I was very impressed at the improvements they had made.  The music was better, the sermon was better and the entire experience was much better.  Churches are notoriously slow to make these types of changes.  So what was at work here?  Was it the “unseen hand” of God?  No, it was the “invisible hand” of competitive markets as described by economist Adam Smith in 1759.

Adam Smith was one smart guy!

This church made these changes because a large, very popular, mega-church in a near-by city decided to build a satellite church two miles down the road.  When faced with this strong competitive threat, the church quickly made the improvements necessary to retain, and even grow, its congregation.

Competition is an essential part of our free markets.  Promoting competition   is a key factor in the U.S. economy being the largest in the world.  Americans love competition. That is why billions are spent on professional sports.

Companies compete aggressively for consumers’ dollars.  This results in better products, better service and lower prices.  When competition is reduced, you get lower quality products, poor service and higher costs.

When government provides services, competition is reduced and usually product/service quality suffers and costs (which are the taxes that pay for it) increase.  The best example of this is education.   The idea of providing standardized education to all children was a great and noble concept that worked well for years. But in the absence of competition:

-        Product quality diminished

-        There is a lack of innovation

-        There is strong resistance to change

-        People have figured out how to “scam” the system for their financial gain

-        Costs have skyrocketed (can we just pass another levy?)
 

We have tried to increase competition in education by way of vouchers.  So far the public schools have spent more time and money trying to thwart the new competition rather than trying to improve their product.

The Affordable Care Act (ACA) now gives government a larger role in the healthcare markets.  The ACA is supposed to help limit the growth of healthcare costs, but I see nothing in the law that actually does this.  Usually more government control means less competition and less competition always leads to higher costs.

In addition, the current government healthcare programs (Medicare and Medicaid) waste large amounts of money from both illegal fraud and “legal” gaming of the system.  It can be assumed that the ACA will result in similar waste as soon as people figure out how to take advantage.

Whenever proponents of the ACA admit that costs will go up for individuals, their answer is that the higher costs will be offset by government subsidies.

This would be fine if the government was sitting on a big old pile of money that needed to be spent on something.  But we are broke. It’s really the Unaffordable Care Act and who do you think is going to end up paying for all the expensive promises the government has made?  The costs are going to start rising next year and I’m not sure they are ever going to stop.

And the economic law of “Unintended Consequences” continues to impact the ACA.  The benefits and number of new people getting insurance is greatly overestimated.  The estimates were based on companies just accepting the new rules without responding.  But businesses are cutting employees hours, limiting hiring and doing whatever is necessary to control costs. 

Nobody knows exactly how this will all play out because people are finally reading the entire law and getting legal clarification of all the confusing details. More onerous, costly, provisions are suddenly being “discovered”. This could get very, very, ugly.

The best solution to the healthcare problem is to increase supply and competition so that the cost of healthcare is reduced to the point where it is truly affordable, with government having a limited role in managing the process. 

Some “Experts” Got Some Splainin' To Do!

The initial GDP estimate for Q4, 2012 came in at -0.1%.  Yes, NEGATIVE! 0.1%.  And the economic world was shocked.  Economists were shocked, commentators were shocked and government officials were really shocked.  It was in a word SHOCKING!  This was truly an economic tremor, because no one, absolutely NO ONE saw this one coming!

Shocking News?  Really?

Well maybe not everyone was so shocked.  And just maybe you might know someone who may have thought this was happening.

From my December 9, 2012 post “A Very Ugly Freight Market”:

“The freight data is consistent with my forecast that the economy is bouncing between 0-2% GDP with no upward momentum.  It appears that we are falling to around 0% (the bottom of this cycle) at the end of the year.”

The Freight Market Doesn’t Lie!

The government economy gurus blamed the contraction on “weather” and decreased government spending.  This is the equivalent of your brother-in-law telling you for the tenth time why he can’t pay you the money he owes you.  It all just sounds like blah, blah, blah, blah at this point.  It is however more reassuring than “We are total morons and we have no clue what we are doing.  We are hoping things get better soon, but don’t expect it.  Check back with us in three months and maybe we will be smarter then.”

While the government was claiming the number was not that bad, some economists say the number could have been lower than -1.0% due to changes in the GDP deflator.  However the trend has been to revise the GDP up from the first estimate, so it would not be a surprise to see a final number around positive 0.3%.

What Now?

The recent January economic numbers have been more positive, so it doesn’t appear we are headed for the mini-recession that I expected at the beginning of last year. It should be noted that no economist on the Wall Street Journal panel forecasted a GDP lower than 0.9% just two weeks ago.  To all those economists who forecasted 2% growth for Q4: You got some splainin’ to do!  Here are the current 2013 GDP forecasts from my economic panel (my 7 favorite economists from the Wall Street Journal Panel):

Q1	Q2	Q3	Q4
1.2%	2.0%	2.3%	2.6%

This looks good to me and I think we can get to 3%in Q4. (So does my favorite economist Jim Meil from Eaton at +3.1%)

Latest Jobs Report

The economy generated only 157,000 in January.  Some commentators had the audacity to say this is positive news and a reason to be optimistic.  Let me put this into terms anyone can understand: this number is AWFUL.  It is TERRIBLE.  It is ROTTEN.  It is APPALLING.  It is ABYSMAL.  It is, okay my thesaurus ran out of words, but you get the idea.  Let’s put this into perspective. If you fill Ohio Stadium with people and then add another 50,000 (half-filled again), that’s how many people went back to work in January.  But there are over 22 million people looking for a “regular” full-time job.  At this pace the unemployment rate becomes a big issue in the NEXT presidential election!

Since my last post on the problems measuring the total unemployment rate, I learned about the SGS Alternative Unemployment Rate calculated by Shadow Government Statistics that attempts to measure just that.  The SGS rate was at an all-time high of 23.0% in January (unchanged from December).  If this is true, it should scare the hell out of us.  The unemployment rate peaked at around 25% during the Great Depression.   And President Obama just disbanded his “Jobs Council”?  Somebody in the government got some splainin’ to do!

Model T Update:

The model is predicting an S&P 500 Index peak of 1550.  If the market has not reached 1550 by May, then consider making a move at that time.  Some commentators are urging people to sell off now.  This is common near the end of a run, but I do think the market has some steam left.  On the other hand, the Model T has shown a variance of +/- 2%, which means an S&P of 1519, could be the top. The market closed at 1512 today, so we are now very close to the bottom of the “sell” range. 

The Unemployment Situation Is A Gooey Mess

I have stated before that unique situations created by the Great Recession have rendered some traditional economic indicators unreliable.  And I believe that the indicator that has been impacted the most is the Unemployment Rate reported by the U.S. Government.

Try Getting Your Hands Around This

This post was initially supposed to be an in depth analysis of the current Unemployment Rate.  Soon after starting my research, I found myself looking at a large pile of goo (if you are unemployed you may substitute “poo” for “goo” or probably a much stronger term).  There have been several articles recently about why the Unemployment Rate is not an accurate measurement of this labor market.  People are constantly trying to adjust the rate based on a single factor.  However there are many factors impacting the job market and these factors are very difficult to measure.
 

Sure, you can still calculate the Unemployment Rate percentage, but it is now just a statistic.  It is not an accurate indicator of the job market.  It is useless to put it on a historical chart.  The recessions of the past occurred primarily in a “blue-collar” labor force.  The recession hit, workers were laid-off.  The recovery begins and people returned to work, often at their previous jobs.  But the Great Recession hit all workers and created some dynamics that are very different.

The Unemployment Rate is greatly impacted by the number of people actively looking for work (the labor participation rate).  Many people have stopped looking for work, but for many different reasons.  For example, Fred the Engineer, age 59, was downsized from his job after 30 years with his company.  In previous recessions layoffs were based on seniority, but in the Great Recession they were based on salary.  Fred looked for a job, but nobody needs an aging engineer in a slow economy, so after exhausting his severance and unemployment benefits, he decides to retire at age 62.  He is not counted as “unemployed”, but he is a “forced” retiree and would gladly be working if a job were available.

The labor participation rate is being impacted by these “forced retirees”, people going on “disability” due to the more lenient government standards, the discouraged workers who have temporarily stopped looking due to the tepid job market.  There are also “mismatched workers” whose jobs were eliminated by new technology and who lack the skills to function in the new economy.  If these people are younger, they may drop out of the labor force to be reeducated, if they are older, they often become the long-term unemployed.  And of course you have the “benefit riders” that ride their benefits out to the end, before seriously looking for work.

The great majority of unemployed people are actively searching for work and hate being without a job.  However, in 2011 a construction worker told me he wasn’t really seeking work because he was on the “Obama Plan” and was enjoying his extended unemployment benefits.  Miraculously, he found a new job just weeks after his benefits ran out.  So yes, it is true as many others have pointed out: If you pay people to be unemployed, you get more unemployed people.

Another factor that is difficult to measure is the thousands of college graduates of the last five years who cannot find jobs in their field of study.  They either have no job or are woefully “under-employed” which may mean a job in fast food.  The underemployed (which aren’t accurately measured) also include the “Fred the Engineers” who are not old or wealthy enough to retire and are working full time at the local telemarking firm.  It is taking some professionals longer than four years to return to work in their field.

Since the Unemployment Rate is currently of marginal value, we are left with the monthly jobs reports (from the government and ADP).  And this measures the number of jobs creted, not the quality of these jobs.  Replacing a manufacturing job with a call center job is not an even swap.

The latest government report said 155,000 jobs were created in December.  This rate of job growth is woefully inadequate to provide for the millions of people seeking work (or better work).  I am hearing about more layoffs and hiring freezes from my local contacts.  And the current plan for creating more jobs is “there is no plan”.  

We need more precise information to better gauge and track the employment/unemployment situation.  Employment surveys need to ask people the reason they are not seeking employment, if they would work if a job was available, and whether they are “underemployed” if they have a job.  There is an opportunity here for a university or survey firm to create a new index.  Hey, that would even create a few more jobs!