is chronic inflation on the way?

I’m going to write about this topic in two posts.  Today will cover background; tomorrow will ask/answer where we stand now.  In a way, these posts are a follow-on to writing about the employment situation in the US.


What is it?

Inflation is a general rise in the level of prices–in other words, in the cost of stuff–that continues over a period of time.

…in a service economy

In a service economy like the US, the largest element in the cost of most things–from financial advice to medical care to computer hardware/software to restaurant meals, and on and on–is the wages paid to the people providing the public with services.  Goods, too.  Because of this, inflation in the US is all about continual rises in wages.

Increases in industrial raw material prices can end up creating inflation here, but only under a number of conditions:

–the price increases for materials can’t be just one-off.  They have to keep on coming.

–manufacturers/ distributors have to pass these cost increases on to consumers by raising their prices, not just absorb them themselves, and

–consumers have to pass the extra costs on to their employers by demanding–and receiving–steady wage hikes.

don’t get inflation started!

Like a lot of things in economics, inflation is partly a state of mind.  A Fed study done when I was just starting out in the stock market demonstrated that at that time consumers’ expectations about future inflation corresponded almost exactly to what actual inflation had been over the prior five years.  It’s not all that surprising that people should extrapolate from recent past experience (what else would you do?), but a problem nonetheless.  If everyone gets it into his head that prices are rising at, say, a 5% annual rate and demands a wage increase that keeps him whole.  So inflation can get institutionalised, as it did in the late 1970s, and become very hard to eradicate.

Multi-year labor contracts may stipulate that wages are automatically increased for inflation–and the define inflation through an index like the Consumer Price Index, which systematically overstates the effect of price rises on the cost of living.  Not a huge issue for today’s US, though.

In addition, inflation tends to feed on itself and starts to accelerate.  In the late 1970s, when an extra-loose money policy sparked inflation, which went from 3% in 1972 to well over 10%–with widespread conviction that inflation would continue to rise–before Paul Volcker stepped in in the early 1980s.

money spigots now wide open again around the world

It’s certainly true in the US and in Japan, and increasingly so in the EU.

The idea is to make the cost of money very low so entrepreneurs will invest and, at the same time, to make the returns low enough on “safe” investments that savers will feel compelled to provide capital.  Why do this?   …to counter the huge economic contraction set off by the near-collapse of the world banking system five years ago.

The risk to this strategy is that, at some point, more productive capacity will be added than there are workers to man it.  If so, labor-short companies will start to poach workers from other firms by offering very large salary increases.  Voilà!  Inflation–always about wages in the developed world–is kindled.

More tomorrow.

the May 2013 Employment Situation report–better than ADP led Wall Street to believe

the May Employment Situation


As usual, at 8:30 edt this morning, the Bureau of Labor Statistics of the Labor Department released its Employment Situation report for May.  The results were almost exactly what the average for monthly job creation in the US over the past year has been:  +175,000 new positions, +178,000 in the private sector, -3,000 in government.


The report also contains the usual revisions of the figures for the prior two months:

— March job gains were initially put at a weak +88,000.  That was revised up to +138,000 in the April ES and again to +142,000 in this morning’s edition.

–April job gains were reported at +165,000 last month and revised down to +149,000 today.

The net result of the two revisions is a loss of 12,000 jobs.

glass half-full?    glass half empty?

for optimists

The US economy has about 1.5 million people each year finishing school and looking for their first jobs.  That’s 125,000 a month, on average.  Creating enough new jobs to absorb these new entrants is an important economic goal.  The US is doing this consistently now.

for pessimists

The unemployment rate is currently 7.6% of the workforce.  This means there are something like 3.5 million – 4 million people who would like to be working but can’t find jobs.  Whether all of these people have the skills to actually qualify for the available openings or not is a subject for debate (my personal view is that at least half don’t–which is a whole other social/political issue).

But just manipulating the numbers, the labor market is absorbing new workers plus putting the chronically unemployed back to work at the rate of 50,000 a month.  At this pace, it will take over five years for all the latter to start drawing a paycheck.

for Wall Street

For stocks, it seems to me that the May ES is good news, because it says the job market isn’t dramatically better or worse than it has been for a long while.

On Wednesday, stocks went down and bonds went up after the monthly survey commissioned by payroll company ADP reported that the economy had added a disappointing +135,000 jobs in May.  Wall Street has been scanning the horizon for signs that the sequester is damaging economic growth and took the EDP report (which is notoriously out of step with the government ES) as a precursor of similarly bad news from the May ES  (don’t ask me why).  That turns out not to be the case.

On the other hand, job creation isn’t accelerating–meaning that the Fed isn’t about to put plans to raise interest rates from today’s emergency-low levels into higher gear.  Arguably, that’s the best news bondholders could reasonably expect to hear.

In short, we’re back to where we thought we were pre-ADP.  My guess is stocks go sideways today.  It will be instructive to see if stocks either break up or down.  The former would really surprise me.  To my mind, though, the pattern of relative industry performance will be the most important thing to watch.



an Abenomics scorecard

summing up Abenomics

Abenomics is the name given in the press to the radical macroeconomic rescue policies promiseded by Japanese Prime Minister Shinzo Abe in his successful election campaign last year.

The idea is to try to end a quarter-century of economic stagnation through the firing of three “arrows”:

1.  a massive increase in the domestic money supply

2.  further stimulus through deficit government spending, and

3.  structural reform legislation.

In many ways, this is an all-or-nothing bet.

Arrow #1, which is already in flight, has triggered in a massive 20%+ devaluation of the Japanese currency–and a consequent staggeringly large loss of national wealth.  Arrow #2, which is in the bow, will add to Japan’s massive national debt–run up to dangerously high levels through decades of politically motivated but economically wasteful porkbarrel government spending.

The consensus view of economists throughout the world, which I believe is correct, is that this “all in” bet depends crucially on the success of Arrow #3.  My view has been, and still is, that it will never leave the quiver.

For  Japan’s sake, I hope I’m wrong.

the Japanese stock market as barometer

I’m writing this post to make two points.

1.  One of the main arguments being used for the potential success of Abenomics in jump-starting the Japanese economy is the strong performance of the Japanese stock market since last July.  This performance, however, is considerably less than it’s made out to be.

From the low point for Japanese stocks last July 26th to the peak of the market (so far) on May 22nd, the main indices rose by about 85% in local currency terms.  They’ve since fallen by almost 18%, for a net gain in ¥ since July of 50%+.

Factor in the currency loss and the return in US$ is 20.2%.  That’s almost precisely what the S&P 500 has done over the same time period.  It’s well below the 35%+ gain in US$ that European stocks have posted.

2.  To my eye, the daily fluctuations in the Japanese stock market over the past ten months have been uncharacteristically wide.  This suggests to me that the main actors in the market have been foreigners.  Not just any foreigners, either.  I suspect the current market bulls are top-down investors driven by general macro concepts–and without much knowledge or experience of the Japanese economy or its securities markets.  I don’t detect any great desire for Japanese professionals to participate.

I’m not sure what this means, if I’m correct.  My experience is that Japanese institutions don’t often cover themselves with glory in their domestic stock market.  On the other hand, they have the inside track in assessing what is/or is not possible politically.


In short, I think there’s much less positive about Abenomics than meets the eye.




Macau Gambling: May 2013 Market Results

The day before yesterday, the Macau Gaming Inspection and Coordination Bureau published the aggregate amount won from patrons by the casino industry in the SAR.  Results were as follows, in millions of MOP (Macanese patacas):

Monthly Gross Revenue from Games of Fortune in 2013 and 2012
Monthly Gross Revenue Accumulated Gross Revenue
2013 2012 Variance 2013 2012 Variance
Jan 26,864 25,040 +7.3% 26,864 25,040 +7.3%
Feb 27,084 24,286 +11.5% 53,948 49,325 +9.4%
Mar 31,336 24,989 +25.4% 85,284 74,314 +14.8%
Apr 28,305 25,003 +13.2% 113,589 99,317 +14.4%
May 29,589 26,078 +13.5% 143,178 125,395 +14.2%

Source: Macau Gaming Inspection and Coordination Bureau (DICJ)

At MOP 29,6 billion (US$3.7 billion), the monthly gaming win for May was the second-highest on record, exceeded only by the MOP 31.3 billion posted during the holiday season in March.  It was also a 13.5% year-on-year gain.  The strong–but not blowout–comparison came against the last healthy month of 2012. From June onward, a combination of economic slowdown and the desire not to attract much attention in advance of the change in leadership of the Chinese Communist Party caused a stagnation in market win until last December.

what to look for in market development

1.  Although what will likely turn out to be a 15% yoy growth rate for 2013 is nothing to sneeze at, it would no longer be the gold rush we’ve come to know and love in Macau.

Normally, I’d guess that maturity for Macau gaming will be 10% annual growth–because that would basically in line with my guess at China’s trend nominal GDP expansion rate.  But since China is attempting a macroeconomic transition away from low value-added manufacturing based on large wage increases rather than currency appreciation, I want to pencil in a higher number.  I’m just not sure what it should be.

2.  In addition, I don’t think Macau is mature quite yet.  Better transportation links will allow the SAR to reach progressively deeper into the mainland for customers.

3. Macau is unique in my experience, because it is dominated by high stakes baccarat played by extremely wealthy, highly skilled gamblers who don’t lose a large percentage of their bets and who have a large chunk of their losses rebated back to them as the price of their patronage.

In contrast, upper income, but not insanely wealthy, gamblers in Las Vegas have percentage losses on their bets of about 10x what the high rollers do.  So the broadening of the market to include more of the first group may bring profits to casinos that are very much higher than Hong Kong analysts now expect.

4.  Market momentum is moving toward Cotai.  That’s the newest area.  It’s also where the new capacity is opening. Galaxy Entertainment and Sands China are the prime beneficiaries.

5.  Former also-rans are now leading the pack.  Operators like Wynn Macau, who have been the most desirable destinations as well as efficient since opening in wringing every last avo (1/100 of  pataca) from their plant and equipment, will stagnate in gaming operations until they can open new capacity.

5.  Non-gambling offerings–restaurants, shows, retail–are in their infancy in Macau.  In pre-Great Recession Las Vegas, they brought in half the industry’s profits.  If Macau follows suit–and I don’t see why it shouldn’t–this could be an enormous positive surprise to Hong Kong investors.  Wynn Macau and Sands China will likely be the stars in this arena.

how are your mutual funds doing?

the SPIVA scorecard:  index funds rule!

Standard and Poors did a major overhaul of its website a while ago.  I’d been delaying getting familiar with the new layout while the old site still held the information I usually look for.  But S&P shut down the old page with monthly performance on it, and I was forced to move too.  I eventually found the performance data, but while I was poking around, I also stumbled across a SPIVA (S&P Indices Versus Active Funds) Scorecard report for yearend 2012.

The scorecard tally?  …about what you’d expect.

Over the three-year period 2010-2012 (all bull market) and the five-year period 2008-2012 (includes both bear and bull periods), the typical equity fund and thee typical bond fund underperformed its benchmark index.

Three exceptions:

–the median small-cap international fund outperformed its benchmark.  This is a small category, however, and all the outperformance seems to have come from having a rip-roaring 2013.

–the median large-cap value fund also outperformed.  Unfortunately, the S&P 500 Value index lagged the S&P by an average of 180 basis points a year over the past half-decade.  Actively-managed large cap value funds performed more or less in line with growth-oriented funds and “core” funds that compete against the plain-vanilla S&P 500 rather than a style-tilted version.

–investment-grade intermediate bond fund managers outperformed as well.  But, like the value equity managers, they had the weakest benchmark.

fewer funds

Over the past five years, almost 27% of the domestic equity funds either merged with other funds or simply liquidated.  23% of international equity funds did the same, as did 18% of fixed income funds.  These were presumably the ones with the worst performance records–the fund industry burying its dead, as it were.  That’s also a huge percentage.

why hire an active manager?  why not index?

For almost everyone, in my view, indexing is the way to go.  It’s the cheapest.  Because your focus on getting exposure to the asset class (stocks) at the lowest possible cost, fewer things can go wrong.  This means less time, effort and skill needed on your part to monitor this part of your overall portfolio.

Why don’t more people index?

–It’s kind of boring.  Just look for the biggest index fund (it’s Vanguard).  It’ll have the lowest costs and the most faithful mirroring of the index.  And you’re done.

–Some people have motives other than making money for being in the stock market.  Some actually like risk for its own sake, believe it or not.  Others want to feel special or be the center of attention at parties.  They likely also want the $200 oil change at the Mercedes dealer (where you get coffee and a bagel, too), not the $30 deal at Jiffy Lube.

–Many financial advisers dislike index funds.

There are typically no trailing commissions (recurring payments from the fund management company while a client continues to hold the fund).  No information seminars or reward meetings, either.

Suppose I’m your adviser and I say, “Let’s take the $1 million you’re allocating to stocks and put it in the Vanguard S&P 500 index fund.  We’ll leave it there forever.  By the way, I’m charging you $1,000 a month ($2,000?), again for ever, for this advice.”  At some point, you’re going to baulk.

More than that, because they charge high fees, actively-managed fund complexes have big marketing budgets.  And, unless they have a huge indexing operation, they don’t have cost-competitive index products.  So almost all the ads you see are for active management.  A lot of them air on financial news shows on cable.  Fat chance the talking heads will tout indexing.

one consolation for holders of actively managed funds

At least they’re not hedge funds, which continue their decade-long record of underperformance of traditional equity managers.

Keeping Score, for May 2013

I’ve just updated Keeping Score for May, which showed a sharp reversal of form among strong and weak sector performance.  I think this is the first step in markets discounting a potential shift in Fed policy toward higher interest rates.