Wednesday, October 11, 2017

Recent & notable charts

Here is a collection of charts, in no particular order, that I have updated in the past week and which I think are worth noting. If they have a common theme, it's that economies both here and abroad continue to improve.

The message of this chart is that the real value of the S&P 500 index has increased in line with the physical expansion of the US economy for the past 45 years. As a proxy for the economy's physical size, I've used the American Trucking Association's index of total truck tonnage hauled by the nation's truckers. I note that there have been a few times when equity markets have diverged significantly from the the trucking index, particularly the late 1980s, the late 1990s, and during the depths of the 2008-2009 recession. I would characterize those as periods of excessive optimism and pessimism—sentiment not warranted by the progress of the overall economy. Currently, the advance in equity valuations seems to be very much in line with the growth of the economy.

Today the Japanese stock market reached a two-decade high, after not making much progress on balance for a very long time. It's interesting that this occurred despite the fact that the yen has been strengthening of late against the dollar. As the chart above shows, since 2005 Japanese equities had shown a strong inverse correlation to the value of the yen (e.g., equities would rise as the value of the yen fell, and vice versa). People have made various attempts to explain this inverse correlation, with perhaps the most convincing being that the Bank of Japan has been pursuing misguided monetary policy at times, such that a stronger yen (one result of very tight monetary policy) put a lot of downward price pressure on Japan's industries (because it made their products more expensive to foreign buyers), while a weaker yen mitigated this pressure and eventually became "stimulative." I'm not quite sure what to make of the action offer the past year or so, but I think it may be that the yen has settled into a reasonable valuation zone. Perhaps not coincidentally, my calculation of the Purchasing Power Parity exchange rate between the yen and the dollar is about 114, which is very close to the current exchange rate of 112. This further suggests that central banks have been doing a pretty good job of managing things, and currencies are trading at reasonable levels in general. (The Fed's Real Broad Trade Weighted Dollar index is currently very close to its 45-year average, by the way.) This suggests that the uncertainties that arise from significant currency fluctuations have been mitigated, and that further suggests that economic fundamentals have become more conducive to investment and growth. Reduced uncertainty is almost always good for investors, and for investments, and for economies.

As the chart above shows, property prices for commercial real estate continue to rise, and have clearly surpassed their prior peak. You hear a lot these days about how shopping malls are dying all over the country (thanks to predators such as Amazon), but this suggests that things are not necessarily bad at all in general.

The charts above are based on Bloomberg's calculation of equity market capitalization. I note that non-US equity markets have been strongly outperforming their US counterparts for most of the past year. However, all markets have registered equivalent gains for the past decade or so, on balance. We're in a global recovery that shows every sign of continuing.

The September ISM survey of service sector businesses in the US was extremely strong, as the chart above shows. This could well be one of those random blips, but at the very least it suggests that the US economy continues to improve. It's also worth noting that a similar index of Eurozone service sector businesses has been trending higher for the past several years. It looks like we're in a synchronized global growth cycle.

I've commented often and for years about the curious and continuing dance between gold and TIPS prices, as illustrated in the above chart (see a recent post here). I've also commented on how the real yield on 5-yr TIPS (shown inversely in the chart in order to serve as a proxy for their price) tends to move in line with the real growth trend of the US economy. With 5-yr TIPS real yields only slightly above zero, the market is apparently unconvinced that any good will come from the Trump administration, at least insofar as something that might push the US economy out of its 2% real growth rut. If there is anything that makes a convincing rebuttal to the widespread claims that the market is insanely optimistic and egregiously overpriced, this chart is it. If the market were convinced that the economy was on the cusp of growing 3% per year or more, I think real yields would be significantly higher and gold prices would be significantly lower.

The most recent survey of small business optimism showed a downtick, but the index is still at rather lofty levels. Small business owners are already seeing a reduction in regulatory burdens, as are banks. It may well be the case that entrepreneurs are already gearing up for better things ahead, but that we won't see the results (e.g., more hiring, more investment) for some months to come. These things take time to unfold.

As the chart above shows, car sales had been in a disturbing slump since last year. Fortunately, the September numbers revealed a substantial bounce. This may be just one of those quirks of seasonal adjustments, so we'll have to wait for a few more months to declare victory, but it is nevertheless encouraging. 

Saturday, October 7, 2017

Healthy households

A few weeks ago, I had some charts (the last two in this post) that showed how our net worth as a country on a real and per capita basis has reached new all-time highs. Our collective prosperity rests on the value of our savings, our investments, and our capital stock. Regardless of who owns all that money (as of June 2017 the net worth of the private sector was over $96 trillion, with total assets worth over $111 trillion), we all enjoy the fruits of those assets in the form of jobs, services, products, and infrastructure. Does a worker really care who owns the building he works in? Who pays his salary? Who owns the toll road he drives to work on? Who owns the tools he uses? He shouldn't. What's important is that the assets that have generated our record-setting wealth are available to all of us, everyday.

The Fed recently updated its calculation of households' debt service burdens, as of Q2/17. Total household liabilities climbed to a record $15.2 trillion, but that represents less than 14% of total household assets. As the charts below show, households' financial burdens (the cost of servicing debt as a percent of disposable income) are about as low as they have been for decades. And households' overall leverage (total debt as a percent of total assets) has fallen by one-third since its record high in early 2009.

On balance, U.S. households are in very healthy financial shape, and that in turn means that the fundamentals of the U.S. economy are also in good shape.

Friday, September 29, 2017

Tax and deficit scaremongering

The media is full of stories claiming that lower tax rates will cause a huge and damaging increase in the federal deficit and will fail to stimulate the economy. Here are some charts which show that those claims are not backed by historical experience. On the contrary: worrying about tax cuts is not necessarily sensible at all.

The chart above compares top tax rates to tax revenues as a % of GDP. (Comparing taxes collected to the size of the economy is the only meaningful measure of revenues.) Note that despite the huge reduction in tax rates in the early years of the Reagan administration (early 80s), revenues hardly fell at all, and in fact increased at a fairly impressive rate through the late 80s and 90s.

There is not a shred of evidence to suggest that rising federal budget deficits have any impact significant impact on interest rates. In the chart above we see that huge increases in the budget deficit have occurred alongside very low interest rates. Predicting higher interest rates as a result of rising deficits is not supported by the experience of the past.

As the chart above shows, recessions almost always result in very weak tax collections. No surprise: recessions cause incomes and employment to fall; the tax base shrinks and revenues decline. Periods of economic growth almost always cause revenues to rise.

Federal spending almost always rises as a result of recessions. Politicians can't resist spending extra money to "stimulate" the economy, and automatic stabilizers like food stamps and unemployment insurance kick in. The most important influence on revenues and spending is the health of the economy.

The Reagan tax cuts did little if anything to worsen the deficit, which began rising in the wake of the recessions of '81 and '82. The current deficit, relative to GDP, is well within the range of post-war experience.

The chart above makes it clear that people respond to incentives, especially when it comes to taxes. Prior to the increase in capital gains taxes in late 1986, capital gains realizations surged. They then fell dramatically, coming in at about half what the CBO had projected prior to the hike in the capital gains tax rate. Note also that declining capital gains tax rates in the late 90s saw a big increase in capgain revenues—exactly the opposite of what an accountant would have projected. The capital gains tax is the only tax you can legally avoid, by the way. All it takes is not selling something you hold at a gain. If we reduced capital gains taxes tomorrow I would bet a lot of money that federal revenues would rise. I for one would sell a lot of things that I have avoided selling. I would also diversify my portfolio in the process, and I would be much more willing (and able) to invest in new things. As it is, a lot of my money is tied up in gains that pain me to realize. It's the same story for corporations who refuse to repatriate their profits. It's therefore hard to overestimate the potential impact of true tax reform.

The chart above shows that federal spending and revenues today are very much in line with historical experience. The weakness in revenues of late could very well be driven by the anticipation of lower tax rates. Taxpayers have lots of ways to postpone or defer income, just as they can postpone or defer capital gains—if they think there is a chance that tax rates will fall in the future. Corporations can postpone or defer new investment as well. Thus, it's not wise to promise tax cuts in the future and then delay their implementation. That was the mistake that Reagan made with his first round of tax cuts; revenues promptly declined because people were waiting for the second round of cuts.

Meanwhile, there is still little if any evidence to suggest that the market has priced in any meaningful increase in the economy's health. People may be postponing income in anticipation of lower tax rates, but nobody's betting that the economy is going to pull out of its 2% annual GDP growth rut anytime soon.

The chart above compares the real yield on 5-yr TIPS to the real Fed funds rate. It's best to think of the red line as being the market's forecast for the average level of the blue line over the next 5 years. Right now the market is not expecting the Fed to do much more in terms of raising the real rate of short-term interest rates in coming years. That expectation, in turn, is very likely driven by the belief that the economy is going to be stuck in its 2% growth rut for as far as the eye can see.

The chart above confirms that from another angle. Here we see that real yields tend to match the economy's growth rate trend. The current level of real yields is consistent with economic growth of about 2%. If the market were more enthusiastic about the economy, TIP yields would be much higher.

The gold market agrees. The prices of gold and TIPS have been strongly correlated over the years. My interpretation of this is that people are more inclined to buy gold when the economy is weak, and less inclined when it is strong. If the market really believed the economy were about to break out of its 2% growth rut, real yields would be a lot higher and gold prices a lot lower. Why hold gold if the economy is improving? Better opportunities can be found when the economy is healthy and chugging along. Gold and TIPS have been meandering around the same levels of several years, all the while the economy has been stuck in a 2% growth rut.