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James Mackintosh

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.

Spanish nominal bond yield

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.

Spain real yield Read more

John Authers

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

John Authers

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

John Authers

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

John Authers

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

John Authers

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

John Authers

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

James Mackintosh

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.

 Read more

James Mackintosh

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