Wednesday, February 19, 2014

Smoke and Mirrrors

One of the things that has troubled me throughout the past couple years is the seeming mixed messages from the economic indicators. Everything I see tells me that the economy stinks. Yet, there are some indicators that seem to be going the other way. Well, I figured out what is going on. Let's discuss.

Unemployment: Let's start with the obvious one, which is unemployment. There just aren't many jobs out there right now. Nevertheless, we keep hearing that the unemployment number is falling slowly and isn't really that far out of line with most recessions. But here's the thing. The unemployment number can be massaged very easily and one of the ways they do it is to drop off the people who have given up looking for work. There are about three million of those and if you factor them back in, then unemployment rises from 6% to 11%. It goes even higher if you factor in underemployment, which is when people are forced to work at jobs below their level of qualification. Count those people and we're looking at around 16% of the workforce being in employment distress.

Corporate Profits: Consumers are weak. Unemployment is high. So how in the world can corporate profits be up? Hmm. This was quite a poser. The stock market has been flying high on the basis that corporate America is doing great because their earnings and profits are at record levels. But the real economy suggests this can't be. What explains this? In a word: buybacks. Companies have been buying back their stock. The result is fewer shares to spread the profits over. Thus, even though actual profits are flat or lower, the company's balance sheets report higher and higher earnings/profits per share.

Housing Recovery: For some time, we've heard that housing prices have stabilized and have been soaring. How can this be? Well, it turns out that a handful of companies decide that housing was a good investment. They basically assumed that either housing would recover or that someone would bail out the housing market, so they went out and bought more than a billion dollars worth of homes. They originally targeted the hardest hit areas like Phoenix, Vegas and California. When they ran out of homes to buy, they moved to other areas like Atlanta, Charlotte and Chicago.

What this did was place a floor under the market generally, because market numbers are an average across the country, and it caused the housing market in the cities where they went to rise basically by as much as they invested. In other words, they bailed out the places they went, and the result caused the average price of homes to appear to stabilize or even rise a bit. But there's a problem. No one else is playing this game. In effect, they've entered a poker game with themselves. And now they want out. First, they stopped buying more, which brought a "surprise" reduction in home sales in December -- with the markets in which they stopped buying being hit the hardest, e.g. prices fell 17% in Phoenix from a year ago. Now they plan to sell off their properties, which didn't rise as expected in value, over the course of the next 5-6 years. This will send the market back down in those cities right back to where it was in 2008. This is (1) why "the housing market" has been going up, nationally speaking, (2) why the housing market actually was only going up in some cities, (3) why it has suddenly stalled, and (4) why it's in danger of collapsing again.

Inflation: Finally, everyone tells us that there is no inflation. Even government figures estimate inflation close to 0%. Yet, everyone seems to sense that inflation is out there and running wild. What's going on? Well, the obvious answer is that government inflation figures exclude the things that suffer from inflation. Specifically, government estimates exclude food and fuel... the two areas where inflation is occurring most rapidly. Further, the inflation has been hidden in many ways. One prime example involves reducing the amount of product in the containers. Product after product has been cutting the amount in each package by 10-20% and then increasing the price by 3-5%. This records as 5% inflation even though it's actually 25%. Other companies have done things like eliminate coupons, add service charges, eliminate things like free shipping, and substitute inferior quality parts. Amazon increased the amount you need to buy to get free shipping.

In instances like Obamacare, the Democrats and their fellow travelers in the media are picking false points of comparison. For example, rather than compare the cost of insurance from 2010 before the Obamacare mandates started to kick in, they compare today's rates to insurance from 2013, which already includes most of the additional costs added by Obamacare. Moreover, they make it impossible to do a direct comparison because the new policies include things the older ones didn't. It's like forcing a Honda owner to buy a Cadillac and then claiming that because the new car is better you can't compare how much more this cost the consumer.

This is what is going on. The economy isn't in doomsday mode, but unemployment is very high, corporate profits are falling (and the stock market should be), there is no housing recovery, and inflation is out of control. The above is how all of that is being hidden from you.



Critch said...

I've been working for Economic Development for 25 years and folks it's bad out there. Construction companies are taking little jobs they would never have looked at just to keep their employees busy. Companies involved in base manufacturing and reefing are laying off....these companies produce the goods at the bottom that are turned into products as they move up...I have tons of carpenters looking for work, as well as welders and mechanics....something I'm seeing lately is barge workers coming in for unemployment. Another of those base industries....

Tennessee Jed said...

yeah, you are right on the money. Corporate buyback always goes on. There is no real growth, no recovery, and plenty of inflation (they calculate that differently than they used to also. ) I just hope if things go really bad, people don't get so scared they hand over all their freedom ("a good crisis should never be wasted .... sorry folks, elections will be, uh, temporarily suspended."

AndrewPrice said...

Critch, I don't have a direct line to the employment situation like you do to tell anything with that kind of certainty, but I can tell that everywhere I look, the evidence suggests that times are hard and that people know it. People aren't spending money unless they need to, they aren't moving up the job ladder, inflation is obvious, homes are the market for a long time and get discounted several times.

Just based on feel alone, these are some of the worst economic times of my lifetime.

AndrewPrice said...

Jed, That's always a worry, that people trade their freedoms and their rights for a little security.

One counterpoint I will say to that is that right now things aren't good, but no one seems to be in a panic. It's like some giant waiting game out there as people wait to see if things get better or not.

On the buybacks, that's the one that really had me stumped for awhile. Despite the economy stinking, all these companies were announcing record "profits." And the market kept going up based on that. Finally, I read an article that talked about the record number of buybacks and how that affects the balance sheets. Then it all clicked. And then the other day I saw an article about it at CNBC. They said that the buybacks made the balance sheets look great, "but if there aren't real growth in profits soon, that won't help."

Koshcat said...

Unemployment - agree. I like the percent employed number that some (like WSJ) uses which still shows that the country's employment has not improved since 2008.

Inflation - tricky; energy costs have been relatively low (and the asshole tried to take credit for that; Dick!) Sorry. So that has help keep a damper. The other reason it hasn't been as bad is frankly because the economy hasn't recovered. If there was true recovery, prices would skyrocket with all the money pumping. The feds are worried about this and that is the real reason they are shutting it down. If they waited until recovery, inflation would be difficult to control.

I agree with your assessment and I sort of feel a crash coming. Not that I have taken money out of stocks as I can weather one (mostly in 401Ks and mutual funds). I can't tell you when or how. It may be a slow crash and perhaps the buyback is preventing it. These companies have had a lot of cash on their hands but worried about investing in capital. They are also worried about idiots like Obama salivating over it and trying to take it. Their cheapest alternative is to pay off loans like stocks.

The housing issue is weird. It seems people are still having trouble selling but at the same time new homes are flying up all around me. I don't know where these people are coming from or where they are working...

AndrewPrice said...

Koshcat, I think that the issue with the housing market is location. Some spots are doing well, others aren't. DC, for example, never went down because the money never stopped. Some places went up for the reasons mentioned. Some places are going up because people are moving there from the Northeast. There's no hard and fast rule except that for most people their homes are still well below the value they were before the bubble burst.

Agreed on inflation, one reason it isn't worse is that the economy is flat and businesses know they can't pass on much more.

On the market, I feel the same way. Everything tells me the market should crash. And there are some interesting (scary) charts out there showing that we are repeating the Great Depress exactly and that a huge crash is now due. On the other hand, this market seems to be staying afloat on momentum alone and, as they say, "You can't fight the tape." Personally, I've just started reducing my exposure, but not ending it yet.

tryanmax said...

Andrew, your Obamacare example near the end is another way that inflation is obscured. You see this especially in durable goods. They claim the price of a car or a dishwasher is basically flat because you now get so much more! Nevermind that the only options are to upgrade or do without. Effectively, it's a price hike no matter the justification. The big difference with Obamacare is they've removed the option to do without.

tryanmax said...

Andrew, a couple more thoughts related to the comments.

On corporate profits, I guess I knew how this worked even though finance bores me to tears. What interests me is the language, and the term has always been, as you note, earnings per share. So much meaning is in the caveats, it's amazing that most people ignore them.

On a potential crash, I don't think we're going to see one in the sense of a huge economic drop-off. That's the thing politicians on both sides and business leaders fear the most. They would rather slide easily into a long, deep slump than tip over and crash. I sense a lot of defeatism from Washington and Wall Street--they are resigned to hitting the ground but are working on a soft landing.

AndrewPrice said...

Back on yesterday's topic for a moment, two new issues today.

First, Pat Caddell, who get much love from talk radio, is accusing the GOP of wanting the Tea Party investigated by the IRS. This is a distortion of reality that calls into question Caddell's mental state, but it will be parroted by talk radio and he fringeosphere over the next week or so.

And then there's this: LINK.

The article thanks Boehner for helping the Democrats avoid a civil war, but it should actually thank the fringe. What the article says is that the Grand Bargain Obama and Boehner were working on would have split the Democratic Party over entitlements and caused a true civil war within their ranks. But when "Boehner" rejected the deal (or let it die), "he" saved the Democrats. You might hear this repeated by talk radio too. In fact, I'm sure you will: "Sputter, sputter... HE SAVED THE DEMOCRATS PEOPLE!!!"

The truth, however, is that the people who killed the deal were the fringe. They savaged Boehner for proposing it, they threatened to do whatever it took to stop it, and they threatened to destroy anyone who voted for it. Add another Pyrrhic victory in the fringe cap.

AndrewPrice said...

tryanmax, What's funny about the Obamacare example is that they used to count it the other way under Reagan. Conservatives constantly pointed out that even though the price of a computer or car or whatever was pretty stable or up a little, you were getting so much more for your money. But the inflation index didn't cover that because they simply compared each model year as if they were the same thing. The result was that there was price deflation, but it was never accounted for.

AndrewPrice said...


On corporate profits, I guess I knew how this worked even though finance bores me to tears. What interests me is the language, and the term has always been, as you note, earnings per share. So much meaning is in the caveats, it's amazing that most people ignore them.

Yep. First, finance bores most people, which is why it's so easy to manipulate people -- because they never bother to learn these things and you can deceive them by manipulating the headline numbers just by swapping out words that have specific meanings which most people don't get.

Further, the per share thing is interesting. I routinely see journalists who don't understand that share price is meaningless. What matters is total valuation. The financial journalists know this, but a lot of the political journalists don't, hence they compare share price without any idea that one company may be much more valuable than the other even with a lower share price.

On crashing, I can honestly say that I have no idea. I'm really not understanding what is keeping the market up right now except for wishful thinking. What I don't know is if the economy will recover and save the market before the wishful thinking turns to fear. Anything is possible right now -- continued rising, a flat market ("consolidation" - hovering in a small range), a minor crash, a major crash. There are just too many contradictory signals right now.

If I had to guess, I would say that we are range bound within about 100 S&P points and will finish the year right where we are now. But it's impossible to tell because it's not clear what is driving the market... the economy isn't.

IF the market were to crash, you would see the economy tank again. There are many reasons for that. People stop spending when they feel like they're losing money and our economy is consumer based. Businesses are using their stocks for financing, so a crash would hurt their ability to produce, hire and expand. Sellers look to the market as a proxy for the health of the economy in terms of deciding how much to produce, which in turn slows or speeds up economic activity.

tryanmax said...

I think the big difference between the Reagan years and today is that most prices did remain relatively flat while the products improved. Now they are using the improvements as a way to say prices are remaining flat while they really are going up.

On what's upholding the market, I think wishful thinking is all it is, and the folks in the oak-paneled rooms all know this. I can't say that I disagree with the notion that setting the economy down gently is better than letting it nose dive, it's the apparent resignation that I find disturbing.

AndrewPrice said...

tryanmax, That's true. Under Reagan, things were going well... the way they should. These days, things have changed. These days, companies seem more interested in marketing than quality and a lot of what goes on is "what you can get away with" rather than pride of workmanship. I see this as a reflection of the culture of disloyalty that has beset corporate America once they started outsourcing.

On the market, I get the feeling that most people think we're in a bubble, but nobody is sure of that and nobody knows what to do about it. The end result is that the market keeps going up, but is very skittish. This is made all the worse that hedgefunds control something like 90% of all traded stocks, so the stock market really is more of a game than an investment tool these days.

Kit said...

You think we might see a market crash?

How big could it be?

AndrewPrice said...

Kit, I watch the S&P because the Dow is worthless -- too erratic, too dependent on a couple companies.

Right now, the S&P is around 1830. I think we're in a trading range of 100 points with the current top of the range being around 1900 and the bottom just below 1800. The range is slowly drifting upward. If we break below 1800 convincingly, then we could head south. If we do, the technicians say we could be looking at something as low as 1600 (12%). Others say that such a fall could cause a more generalized panic and could push the S&P to 1200 (35%). Then there are a couple people who are predicting Great Depression 2 and they say 600, but I don't put any faith into that.

My guess (based on seasonal histories) is that we hover between 1800 and 1900 until September. Between now and mid-March, we drift up just above 1900. Then we slowly drift down to just below 1800 in mid-June. Then we get a summer rally on light volume through early-September taking us back to 1950 or so. Then the "crash" happens. I suspect the crash takes us back to 1600 before we get a November-December rally.

At that point, I have no idea. It will all depend on the economy.

Also, this is all pure speculation based on prior market trends. Anything could really happen.

Kit said...

Sounds a bit worrying. Could it cause a 2nd recession?

Kit said...

By the way, Ukraine is getting worrying.

Here is a link to the Mirror where they have live footage of the protests/riots. And the fires. Right now there is some cheesy 80s-style music playing over the footage. No idea why.

AndrewPrice said...

Well, I would argue that we never left the recession in the first place except technically. But yes, if the market falls in a way that makes people use the word "crash," then that will likely hurt the economy.

In terms of it being worrying, it is worrying, because the market could drop a ton or it might not... there's no way to tell and you can't really sit on the sidelines either. Investing right now feels a bit like Russian Roulette.

Kit said...

Well that sucks.

AndrewPrice said...

That's the investing understatement of the year, Kit.

Kit said...

Washington Post analyzes the likelihood of a Civil War in Ukraine. (Not likely but possible and things could still get really bad).

AndrewPrice said...


Kit said...

He does not touch on the fact that Lviv has apparently declared independence from the government. Not the country, just the government.

So, let's see how this year is going.
MASSIVE Civil Unrest in the Ukraine
Syria is still in a civil war with fighting pretty much in the same cities it was in 2 years ago (Homs, Aleppo). Really, I don't think the front lines have moved AT ALL since the war began.

In America:
The GOP is finally starting to get its act together.
Cruz is still a dick
A stagnant national Economy that may have a crash later this year.
Obama is still... Obama.

Overall: Good? Bad?

AndrewPrice said...

Kit, I have no opinion on the Ukraine. Could be a real mess.

Koshcat said...

It may actually be better if the big drop happens all at once. Then those of us who are concerned (and I think there are a lot) would feel more comfortable investing. If it happened all at once and early it would be forgotten by the end of the year. If it is a slow torture, I fear it may be even worse because it is like a slow bleeding which is draining.

Ukraine is a little scary. If the military has a coup, the Russians may get involved and then it would get very bloody. Not to mention that this couldn't happen with a more internationally incompetent president ever.

AndrewPrice said...

Koshcat, If we had a serious, fast drop, I would view that as an amazing buying opportunity. I think our biggest danger is not a collapse, but just continue malaise. And you're right, that is very draining.

Post a Comment