Falling prices are great if you’re a consumer. They’re no good if you’re an indebted government.
One measure of this is the interest rate the government pays, adjusted for inflation. If tax revenues rise roughly in line with inflation – and they should move br0adly with the GDP deflator as a measure of total economy prices – then higher prices equal higher tax revenues and so more ability to service debt.
Higher inflation means higher nominal GDP growth, no matter what is happening to real GDP. The result is smaller debt relative to the size of the economy – even if price rises have not left voters any better off (as measured by real GDP growth). Because bond coupons are fixed, inflation is good for borrowers and bad for lenders.
Here’s the good news on Spain: nominal 10-year bond yields and the extra interest it has to pay relative to Germany are both sharply down.
Here’s something less positive: Spanish bond yields adjusted for the GDP deflator – in other words, how much help the Spanish debt is getting from nominal GDP growth.
We all now know that the Federal Reserve opted not to “taper” last week. In other words, it kept its monthly purchases of bonds at $85bn without reduction, in a move that was a surprise to many, even if the FT had made clear for a while that a taper was no foregone conclusion.
But have others been tapering already? The official Treasury Department data show that foreigners have this year started very gently selling down their positions of Treasuries. This is the chart:
The move is not great, but it is there. To be precise, foreign holdings of Treasuries reached $5.72tn in March, and by the end of July were at $5.59tn. This is no great change in itself, but it is changes at the margin that matter – and we already know that a “taper” or otherwise in the Fed’s bond purchases was able to generate a dramatic market reaction. So what is going on? Read more
Lehman has, at last, been bankrupt for five years. I posted the last of the five-video series we put together for the anniversary here. This post is for those hardy few who have still not had enough of Lehman memorabilia. If you have the time and inclination, try looking through some of these videos, which I made at the time (when I was based in New York and still covered the Short View).
First, this video, which we produced for what we then considered to be the first anniversary of the crisis, in August 2008 a few weeks before Lehman, bears re-watching. The key message to be derived from it is that claims that nobody saw the Lehman bankruptcy coming, or the crisis that surrounded it, do not hold water. It features today’s interviewee, the former Olympic fencer James Melcher, and his comments are particularly prescient: Read more
One of the biggest areas of controversy over CAPEs or cyclically adjusted price/earnings multiples (see this earlier post and the huge correspondence it provoked) concerns exactly how earnings are measured, and how they can be compared over time. Neither is a unique problem for CAPE compared with other valuation metrics, but they can still change conclusions over the vital topic of whether the US stock market is now overpriced.
There is action on this front in the academic world, with Jeremy Siegel of the Wharton School proposing that an alternative measure of earnings should be used. This might change conclusions, and there will be more on that next week. For now, I would like to introduce another fascinating attempt to alter the methodology of Yale’s Robert Shiller, who has been central to popularising the CAPE over the last two decades.
Back in 2009, Alain Bokobza of Societe General released the results of his own new normalised CAPE, and his colleagues have kindly updated his data. The essential new insight was that corporate taxation has not been constant over the years. Rather, it was introduced in 1911 at only 1.5 per cent. After the First World War it rose to 15 per cent, and then, as the apparatus of the welfare state rolled out over the ensuing decades, it rose to 40 per cent. Mr Bokobza contends that this affects the multiple that investors will pay. So he recalculated the CAPE for the years before 1950, assuming a 40 per cent tax rate.
To give a quick example; If you pay $100 for $10 of earnings untaxed, you have paid a p/e of 10. If it is taxed at 40 per cent, you have paid a multiple a little above 16 on post-tax earnings. This comparison may more accurately, according to Mr Bokobza, help build a norm for what investors are prepared to pay for the earnings they buy. Without making such an adjustment, Mr Bokobza contends, we are effectively comparing post-tax earnings post-war with what can almost be called pre-tax earnings pre-war. This is a contentious point of view; throughout the period, taxation was a given for investors. Many other factors were also changing. But it makes a case that pre-war multiples may not be directly comparable to post-war ones, and suggests an intuitive fix. (And indeed the comparability of earnings is the subject of growing academic debate, and is very relevant when trying to get a handle on long-run valuations). A look at how this changes the historical picture comes after the break. Read more
Ben Bernanke can move markets, and sometimes his words are too strong for his own good. That may have been true of his press conference last month, when he announced that he planned to start tapering off QE bond purchases later this year, and end them altogether by next summer. That drove a dramatic rise in Treasury yields, and in the dollar.
For a further classic example, look at the speed with which currency markets responded late on Wednesday and early on Thursday to a speech he made in Massachusetts, and to the minutes from last month’s meeting of the Federal Open Market Committee, published on Wednesday. The euro gained 4.5 cents against the dollar in a matter of minutes, while the pound gained almost 4 cents (or about 2.6 per cent). Read more
One of the biggest arguments for emerging markets during their bull market, which started in 2003, was about “decoupling”. The idea was that the emerging markets had now managed to decouple from the developed world, and would be impervious to a recession there. It never worked as it was supposed to, with the arguable exception of a few hectic months at the end of 2008 when China’s stimulus appeared to end. Now, I’d argue, the decoupling has ended, but not in a good way.
I discussed emerging markets with Barclays’ Larry Kantor in a Note video. That included the following chart, which shows that emerging markets have now underperformed the developed world over the last five years, a period that starts roughly with the crisis over Fannie Mae and Freddie Mac in the hot summer of 2008:
Significant EM underperformance when developed markets were performing well is a new experience for many currently operating in the markets. More detail (and charts) after the break. Read more
Yet again, it is time to rain on the parade of the many people who are excited by the new high set on Tuesday by the Dow Jones Industrial Average. The rally in US stocks is impressive, however you measure it. But the Dow remains a fatally flawed index, and there is no reason why anyone should pay any attention to it. I said this as the Dow hit landmarks back in 2006 and 2007. Here goes again.
As an index of only 30 stocks, the Dow is not broadly diversified and is not representative of the US stock market as a whole (the S&P 500, by far the world’s most widely followed index, is more important for that purpose). Its stocks are not uniformly large enough to qualify as a “mega-cap” index (try the Russell Top 50 instead). Neither are they sufficiently dominated by industrials (despite the name) to qualify as an industrial index (the S&P 500 industrials sub-index might work better for that). Read more
Blame the collapse of the USSR: an entire generation of Americans who might once have specialised in Kremlinology now devotes its time to parsing the messages that filter out of the US Federal Reserve.
Minutes of the last Fed meeting released yesterday hammered markets. As usual, when the US sneezed (the S&P 500 down 1.2 per cent) Europe caught a cold (the Stoxx 50 index is off 2.1 per cent as I write and poor old Italy is off almost 3 per cent). Read more
After Warren Buffett’s Berkshire Hathaway agreed, with a partner, to buy Heinz for $28bn, the hunt is on for the Sage of Omaha’s next target. James Mackintosh, investment editor, says Buffett prefers safety to a bargain, but notes that Berkshire has underperformed the market – and Heinz – over the past decade.
If you want to invest like Warren Buffett, there are quite literally hundreds of authors out there ready to help. In the past year alone, two dozen books have been published on the Sage of Omaha, covering everything from his travels to the women he employs.
After Thursday’s acquisition of HJ Heinz for $28bn, I thought it was worth pulling up a list of similar stocks for those who missed Heinz (and its 20% share price pop). Read more
Goldilocks is back! Goldilocks was the famous “not too hot, not too cold” economy which under US Federal Reserve chairman Alan Greenspan was able to deliver rising shares without the Fed pouring cold porridge over asset prices in the form of rate hikes.
Today’s jobs data suggests exactly that can happen again, thanks to the oddity of the market and the central bank focusing on different measures. Read more
The US is about to get a new Treasury secretary, assuming the White House can steer Jack Lew through the painful nomination process in Congress.
One question that’s sure to come up: is he in favour of a strong dollar? Read more
The UK’s inflation-linked gilts markets have just seen their largest one-day rise in 25 years – thanks to the decision of statisticians to do nothing. James Mackintosh, investment editor, looks beyond gilts to analyse what the real yields on government bonds are telling us.
It took just two months of Standard & Poor’s control of Dow Jones Indexes (CME sold it in return for a stake in the new and larger S&P DJ Indices group) for S&P to start thinking about how to reform the venerable Dow Jones Industrial Average, the second-oldest index still going.
It desperately needs reform: three of the US’s 10 largest companies are excluded, and it is calculated by averaging share prices, a daft approach better suited to the days of slide rules. This video explains – charts after the break show how the Dow has performed, and discuss how investors should respond:
As predicted, there is more to say about the London housing market. It is widely known that the buying pressure on prime London properties is coming from overseas. The eurozone crisis and the creation of fortunes by the commodities boom have helped push lots of money into the nicer neighbourhoods of central and west London.
But I had not previously grasped that foreign demand was also driving segments of the market below the true “prime” postcodes, and that that foreign demand is not primarily European or Middle Eastern but rather from Hong Kong, Singapore and Malaysia. That is the strong message from this extraordinary chart from Jones Lang LaSalle, shared by Ed Hammond, our property correspondent, in the latest Note video: Read more
Judging by the response to my Monday column, a lot of people are interested in central London property. As that has been followed by news that a London house is on sale with an asking price of more than £100m, in Hampstead, it’s easy to see why. One of many requests was for more granular data.
Thankfully, I can oblige. London, obviously, cannot and should not be treated as one market. In particular, “prime” central London, because of its appeal to international buyers, seems to follow very different dynamics from the rest of the capital. That appeal varies according to area. The following chart, provided by Hometrack, plots every Greater London broad postcode on two scales – their performance since the overall market first peaked five years ago, and their actual price. Read more
Marc Chandler of Brown Brothers Harriman is always interesting. His take on the QE3 debate, ahead of the FOMC’s next decision, might startle many in the US: the US economy is in an enviable position – why is there any need for dramatic new exceptional measures?
Evidently many Americans do not feel as though they are much to be envied, and unemployment has dragged on at levels that are politically unacceptable. But America’s post-Lehman economic trajectory, with the recovery looking ever more firmly founded, should certainly be the envy of western Europe and Japan. Read more
Whether it likes it or not, the Federal Reserve has been pulled into the political thickets. The demand is for it to “do something”. Whatever it does at its meeting this week will have political ramifications, and you do not need to belong to the Ron Paul faction to question whether further QE of any kind is necessary at this stage.
As James Mackintosh pointed out in the Short View, inflation expectations and asset prices are both rising now, rather than falling as they were before QE1 and QE2. This Fed has a philosophical aversion to deflation, but there appears to be no imminent danger of that. Read more
The most profitable way to be wrong over the past five years was to bet that frantic printing of money by central banks would create inflation – so buy gold. Since the start of 2007 gold has risen at an annualised 19 per cent, a tasty return, particularly when compared to equities.
Yet, there’s been no sign of consumer price inflation, even as the US Federal Reserve explicitly targets asset price inflation (Fed jargon calls this the “portfolio channel” for monetary transmission of quantitative easing; in English that translates as rigging the market). Read more
Mario Draghi has at the very least pulled off a great coup of expectations management. On Thursday he said exactly what everyone expected him to say. Markets had already rallied in hope for more than a month ahead of his announcement. This might usually be the cue for a sell-off, but instead the euro held steady, while peripheral bond and stock markets went to the races.
Spain’s 10-year yield is now below 6 per cent, while the buying opportunity when this risk-on wave started now looks to have been immense. Spanish shares (as measured by the Ibex) are up by a third in the two months, while Eurozone bank stocks (as measured by the FTSE Eurofirst index) have gained more than 50 per cent. I discussed all of this with Jamie Chisholm in the first of the new series of Authers’ Notes:
The larger questions are whether this can continue, and if there is any way to time the risk-on and risk-off waves. Read more