Scarcity and Economic Tradeoffs

Most of us have heard the truism that life is full of tradeoffs. This is indeed a truism because nearly every resource necessary to pursue happiness is in short supply. People must choose between alternatives under these axiomatic conditions of scarcity, lest the resources run dry. The heuristic is an economizing one--consume scarce resources in an order that maximizes satisfaction.

Pervasive scarcity thus drives people to be predominantly 'economic' in their behavior, trading off one thing in order to obtain something else deemed to possess more utility.

A class in economics is not necessary to learn this. Pursuing our dreams demands that we learn about making tradeoffs (i.e., economizing) in our daily decision-making.

Caution Using Economic Indicators

John Hussman offers one of the more thoughtful analyses of leading economic indicators (LEIs) that you're likely to come across. Based on his data, he's pessimistic that recent anecdotal evidence (i.e., downticks in unemployment, upticks in purchasing managers index) are sounding 'all clears' with respect to recession chances.

In fact, Dr J's assessment suggests the opposite: recession appears likely within the next 6 months.

One point I found particularly interesting is that some factors used in LEI analyses tend to 'look good' right up to commencement of a recession. For instance, Dr J notes (see below graph) that payroll growth tends to be positive in 80% of the months where recessions begin! Moreover, payroll growth in the 'recession month' tends to be higher, on average, than the three preceding months.

Obviously, unadjusted payroll growth is not a good standalone predictor of recesssions. Indeed, from the above graph, payroll growth appears to be a lagging indicator of recessions.

Bottom line: be careful what you absorb from the popular press concerning economic indicators and recession potential.

More on AAII Sentiment

More on the AAII sentiment data, this time showing some historical perspective. Note the general behavior in the SPX as this series hits extremes.

As noted yesterday, just one piece of the puzzle, but a piece worth noting...

position in SPX

Individual Investor Sentiment Levels

Sentiment measures seek to reflect to extent to which market participants are optimistic (bullish) or pessimistic (bearish). When sentiment indicators reach extremes, they often suggest turning points. For example, if sentiment indicators suggest most market participants are bullish, then perhaps most of the buying has already occured, and supply/lower prices may be around the corner.

There are many measures of sentiment. The prudent market participant usually watches a bunch of these indicators for general trends rather than focusing on a single measure.

That said, the recent weekly AAII sentiment index numbers, which measures bullishness/bearishness of a group of individual investors, suggests extreme levels of bullishness versus historical levels.

As noted, only one piece of the puzzle. But one suggesting that optimism, at least among a particular category of investor, is getting stretched.

position in SPX

Durable Rally, or Short Term Relief?

If we were to assign news-related causes to today' 2-3% stock market rally, it would probably be a blend of better than expected Black Friday sales plus the spectre of (another) Euro bailout. Of course, we learned today that a) the IMF had no Italian bailout program in motion, and b) last week's retail sales numbers may be greatly exaggerated.

So perhaps today's move is just one more rally to blow off some near term selling pressure.

Technically, an upside move 'works' to SPX 1220.

Other technical evidence, however, is not in synch with a sustained upside move. After an early move lower, Treasuries recovered most of the day's losses. Bank stocks gave up a big chunk of their early gains. The dollar also closed near even after early selling. Oil closed near its lows.

Hard not to view these 'divergences' with some skepticism about the prospects for big upside from here. Time will tell, of course.

Personally, I did a whole lot of nuttin' today. Will likely put back on some of the incremental short exposure ditched last week should prices continue higher toward 1220. Other than that, I continue to be active in the physical metals market, buying both gold and silver.

position in SPX, gold, silver

Weak Payroll Number

Hard to see much good in today's surprisingly weak payroll number. That may not stop the bulls from drinking it pretty, however.

Bulls will likely suggest that weak job reports like this one 'demand' more stimulus from the government.

Quite convenient thinking--given the recent end of QE2.

position in SPX

Questioning the Usefulness of GDP Measures

Most of us have come to accept the validity of GDP as a given. This article questions the usefulness of national output measures.

Arguments against GDP are not new. As the author notes, Mises was on the case years ago. GDP is hardly a measure of 'economic health' as many believe. One need only look at the components of GDP to understand why:

GDP = C + I + G + (X - M)

C = private consumption
I = gross private investment
G = government spending
X = exports
M = imports

As measured, GDP is largely a measure of consumption. In the spirit of 'what gets measured gets managed,' policymakers will likely intervene in markets in order to goose the numbers in their favor.

Interestingly enough, as noted by the author, GDP measurement didn't come about until the 1930s, when New Deal bureaucrats sought a measurement on which they could focus the public's attention on the need for planning to maintain national economic health.

A better argument can be made that long term economic health depends on savings and capital accumulation. Focus on a consumption oriented measure of national output like the one above is more likely to result in capital consumption in order to 'make the number.'

The decline in savings and rise of debt suggest that this is precisely what is going on.

Fudging the CPI Numbers

As part of the federal budget talks, there is a proposal on the table to alter the way that the consumer price index (CPI) is calculated. Essentially, the proposed method would try to take into account the fact that consumers often trade down (e.g., go from steak to hamburger) when prices rise.

If passed, the alteration would make the 'headline' inflation number smaller.

Why is this on the table as part of the budget debate? Because a smaller inflation number would lower federal payouts (such as social security) that include cost of living adjustments. Viola! An instant $200 billion in budget savings.

This would not be the first time that the CPI has been dumbed down. There have been multiple changes to the methodology over the past couple of decades. The weird (criminal?) thing is that when the goverment changes the method, they do not go back and alter the historical series. Those looking at historical CPI data are not comparing apples to apples (the same is true for unemployment, GDP, and other measures). If we were measuring the CPI the same way as in 1980, the headline inflation number would be nearly triple the currently reported level.

How such a practice is viewed as legitimate and is tolerated is beyond me. If I had tried to manage measurement systems like this during my industry days, then I would surely have been fired.

Make sure you understand the dynamic here. The federal government is printing money, which undermines the value of the dollar. Government officials are then supressing the metric that is supposed to reflect the dollar's value, effectively under-reporting reporting the inflationary consequences of their activities.

Weak Jobs Number

Big miss in the jobs number this am. And it should be noted that the 54,000 number includes 206,000 estimated jobs created using the 'birth/death' model of the BLS.

Over the past 3 years, government has borrowed and spent $trillions, and printed and spent $trillions more largely in the name of 'creating jobs.' Yet, anemic employment persists despite the federal government's best efforts to paint the data pretty.

Will markets view this job report thru a glass half full or glass half empty lens? The bullish argument is that weak jobs data will require more government intervention (can you say 'QE3'?).

The bearish argument is that a weak employment situation persists in the face of $trillions of government intervention, suggesting that perhaps prolonged economic weakness is unavoidable.

Real Household Income

Interesting chart showing the disposable income. Over the past decade, real income has basically gone nowhere for the median household.

'Real' income means that it has been corrected for changes in the CPI. For example, if your salary increases by 5% but the prices of goods and services also increase 5%, then your 'real' income in terms of purchasing power has not changed.

There is a fair amount of evidence that the goverment is under reporting the CPI and has been for many years. Some estimates suggest that if we compared apples to apples with older methodology, the CPI is increasing at triple the currently reported rates.

If that it true, then what is the real trend in real disposable income over the past decade?

Alternative Consumer Price Index

This price index developed by MIT provides an interesting alternative to the the US government's Consumer Price Index (CPI) data. Check out the steepening slope over the last four months. Amounts to about 8% annualized.

Which is ~3x the increase suggested by official government stats.

Weak Economic Indicators

Some measures suggest that current economic recovery is on weak footing. I found the petroleum data particularly interesting.

position in oil

FDIC Rate Page

Need to know current rates on CDs? The Federal Deposit Insurance Corporation (FDIC) reports weekly national averages for rates on money markets, CDs, and other deposit products.

As you can see, yields on deposit products remain low.

position in CDs

Baltic Dry Index Less Relevant?

Previously we highlighted the Baltic Dry Index (BDI) as a popular indicator of global trade intensity. This missive suggests that the BDI is losing its relevance as an effective indicator.

Not sure I totally buy the argument. For example, the author suggests that changes in the BDI do not correlate well with returns of major cargo carriers. But the author never demonstrates a strong relationship between the BDI and carriers even before the supposed period when the BDI's effectiveness started to wane.

In any event, it's good to keep in mind that some believe that the BDI is becoming a less relevant measure of global trade.

no positions

Baltic Dry Index

The Baltic Dry Index (BDI) is a price index of international oceanic shipping rates. When the BDI goes up, it implies generally higher prices to ship stuff via cargo vessels around the world.

Many market participants regard the BDI as an indicator of global trade. Higher BDIs imply stonger trade patterns.

During the 2008 credit market collapse, the BDI experienced a jaw-dropping decline--falling from over 11,000 to under 1000 in just a few months.

Over the past few months, the BDI has been weakening once again. Thus it represents a divergence in the thesis that economies are generally strengthening worldwide.

Another metric that may be worth watching...

Defining and Measuring Inflation

This article touches on why inflation, as measured by the Consumer Price Index, is chronically under-reported.

Did you know that the dominant definition of inflation has not always been linked to 'change in prices?' A century ago, inflation was commonly defined in terms of the quantity of money and credit.

You can ponder which definition makes more sense...