Brazil and fiscal dominance

A few days ago I was reading an article in the Economist about structural problems in Brazil, caused by a combination of many years of wildly imprudent fiscal policy and the collapse of the oil and iron ore boom (soybeans, too) that had been preventing legislative craziness from having immediate bad consequences.

Those consequences have since arrived, in the form of deep recession, high inflation and a collapsing currency.  The policy situation in Brazil is grim enough to be described as one of fiscal dominance, a term that has slipped into the economic lexicon without my noticing it (by the way, the Bundesbank has an interesting discussion of its relevance in the EU).

What does fiscal dominance mean?

It’s a situation where a country’s finances are so unstable—high, and rising, government deficit + large outstanding, and also increasing, government debt–that any attempt to raise interest rates runs the risk of driving the government into default.  Investors quickly figure out the extra interest expense that will be needed to roll over existing debt and issue new bonds to fund the continuing deficit.  They know the point where the government will simply be unable to pay.  They don’t wait for that point, of course.  They run for the hills as soon as they reckon this is a real possibility.

As a result, in a fiscal dominance situation money policy can play no role in either stabilizing the currency or fighting inflation.  Fiscal policy, which in Brazil’s case has caused the parlous circumstances it now finds itself in, is the only policy tool available.





the December 2015 Employment Situation report

I thought I was pretty much through writing about the Labor Department’s monthly Employment Situation report.  After all, unemployment is down to 5%, a figure often associated with full employment.  And despite this, the country has been adding new jobs at a clip far higher than the 125,000 or so needed monthly to absorb new entrants into the labor force.

In recent months, however, two lines of thought (if “thought” is the right description) have emerged that argue the ES figures are misleadingly optimistic and that the US is actually on the cusp of recession.

–The first is that the sharp decline in the crude oil price is not an issue of too much supply but represents a falloff in demand,  presaging a drop in economic activity in the US.  The fact that there’s not a much empirical evidence in favor of this view hasn’t seemed to bother its adherents.

–The second is related.  Its claim is that the layoffs in petroleum- and other mining-related industries are of highly paid workers and dwarf the benefits to consumers (both individual and corporate) of lower commodity prices.  Again, imminent recession is the conclusion.


The December ES reports that the US economy added 292,000 jobs last month.  In addition, The October estimate was revised up from +298,000 jobs to +307,000 and the November result from +211,000 to +252,000.  That’s a whopping +284,000 new jobs a month last quarter.

For 2015 in total, the economy added 2.7 million jobs.

This ES also contains figures for the loss of jobs in extractive industries– a decline of -8,000 positions in December and one of -129,000 for the full year.

A related Labor Department report, JOLT (Job Openings and Labor Turnover) indicates that in October US employers had 5.4 million unfilled job openings, about a million higher than at the last economic peak in 2007.



a rough start to 2016

The S&P 500 is down about 2.4% year to date through Wednesday.  Futures indicate the index will open down another 2% this morning.

Three factors seem to me to be involved in this weakness:

–the “normal” selling of last year’s winners that occurs each January by taxable investors who have nursed gains into the new tax year,

–the falling crude oil price, which some influential (algorithmic) traders continue to interpret as a sign of impending general economic weakness   …meaning they sell not only oil stocks but also other sectors that are economically sensitive.

I think this connection will ultimately prove to be incorrect, but until we see the seasonal nadir for oil, which comes in late January or early February, what I think matters a lot less than what they do.

–worries about the Chinese stock market on the idea that it’s a leading indicator of the Chinese economy.  This is a legitimate concern.  Of course, a considerable part of the problem is the hangover from a not-yet-fully-deflated bubble created by wildly speculative, margin driven trading in 2014-15.

In fact, I find it hard to believe that the decline is the result of a sudden realization by Chinese investors of economic trends that have been in place in their country for several years.  On the other hand, I don’t expect weakness in publicly traded, export-oriented state owned enterprises in China to go away soon.

What to do?

The reaction of most investors, including professionals, during times like this is to turn of their stock quote pages and just not look.  This is a more viable strategy than it sounds.  Another way of saying the same thing is that at some point we all have to have faith that we have crafted sound long-term portfolios.  Being frightened out of good stocks by temporary bumps in the road would be a bad thing.  So our number one priority should be not to dismember a good portfolio simply because the market is going down right now.

On the other hand, when the market is weak, there can be a chance to pick up interesting stocks at cheaper prices than normal.  So if your stomach can take it, there’s a good reason to keep an eye on how Wall Street is doing, even if it’s punishing our holdings.

McKinsey: digital “haves” vs. “have mores”

haves and have-mores

The consulting firm McKinsey and Company published a study on the digital economy last month, titled “Digital America:  A tale of the haves and the have-mores.”

It makes two main points:

–the price of information and communication technology goods and services has dropped by about 2/3 over the past two decades.  So conventional measures of GDP are probably underestimating the positive impact of ICT on overall economic growth in the US.

More important for us as investors,

–the pace of digitization varies very widely by company and by industry.  The leaders have increased their digital capabilities over fourfold over the past 15 years.  The rest have 14% of the leaders’ digital presence.  That’s up from 8% in the late 1990s.  But the great mass of firms have barely closed any of the gap.

Laggards have only a fifth of the digital assets of the leaders and have only 7% as many workers performing digital tasks.

most/least digitized


Interestingly, McKinsey lists as the most digitized sectors:

ICT itself

Media (?)

Professional services

Finance and insurance (insurance?).

I guess I have to remember it’s a relative list.


The least digitized are:





Agriculture and hunting.

competitive advantage

McKinsey also points out that the most digitized–think Google, Facebook, Amazon, Netflix–have an immense competitive advantage over their rivals.  That expresses itself in increased market share and higher profit growth–although personally I think we have to take the second on faith with firms like AMZN, which are plowing their cash flow back into expanding their reach.


In a year that will probably be flattish–even though the first couple of trading days make one think of flattish as an aspirational goal–looking to firms who are establishing digital leadership is a reasonable investment strategy.  Growth investors will likely try to find fast-growing leaders, both large and small.  Value investors will probably try to find laggards who now understand their potential predicament and are acting aggressively to remedy their shortcomings.

All we have to do is find names.

more on risk as volatility

volatility as risk

I was listening to Bloomberg radio the other day when a talking head who usually has interesting things to say (an increasing rarity on Bloomberg) began to “explain” how 2015 was a very risky year for stocks.  This, even though the S&P 500 was ending December in basically in the same place it started out in January.

Measures of interday change in individual stock prices were also relatively benign   …but, he said, intraday price movements in stocks were unusually high.  Therefore, stocks were riskier than usual.

Yes, in a very tortured sense…or for a day trader who’s consumed by hour-to-hour price movements…that might be so.  For you and me, though, that’s crazy.


Last September 14th I wrote another post about the academic notion that investment risk can be defined as day-to-day volatility, i.e., the daily change in the price of a given security.

The main pluses for this idea are that it’s simple, the data are readily available and you don’t have to know anything about the security in question or the goals of the holder.

In my earlier post, I pointed out that this notion led to catastrophic results in the late 1980s-early 1990s for institutional holders of commercial real estate and junk bonds.  Neither traded very often, so the daily price–as determined by the last actual transaction–rarely changed. Volatility was negligible.  What a surprise when lots of people wanted to sell at the some time, only to find that low volatility didn’t represent safety.  It signaled illiquidity–there were no buyers at anywhere near the last trade.

not a 100% useless concept

There is a sense in which volatility may be important, though.  Over several year periods, stocks tend to follow an up and down pattern that mirrors the business cycle, with stocks leading the economy by about six months.  Over longer periods, stocks tend to advance on trend around the rate of growth in reported profits, which has historically been about +8% per year in the US.


If you’re in your thirties or forties and saving for your retirement or to pay for your young children’s college tuition, then daily or even business cycle fluctuations in stock prices are irrelevant now.  Investing in stocks that have low volatility–which usually also comes with low appreciation potential–makes no sense at all, despite the notion’s academic pedigree.

On the other hand, if you’re saving, say, for a wedding or to buy a house and will need the funds in six months or a year, then having it in stocks is probably a bad idea.  That’s because prices could easily be 10% below today’s level when you need the money.  Just look at a chart of the S&P 500 in 2015–which chronicles a mid-summer S&P swoon– to see what I mean.  In this case, keeping your money in (low-volatility) cash is the better course of action.