Corporate profits are still healthy

The collapse of oil prices that began over two years took a big bite out of corporate profits, but now that oil prices have been relatively stable for the past year or so, corporate profits are rebounding. Profits are still below their previous highs, both nominally and relative to GDP, but they are still healthy from an historical perspective. Using the measure of corporate profits that comes from the National Income and Product Accounts as the E, and the S&P 500 index as the P, PE ratios are only modestly above their long-term average.

The chart above shows after-tax corporate profits (for all corporations), adjusted for capital consumption allowances and inventory valuation. This is considered to be the best measure of "economic" profits over time, as distinct from FASB profits. Note that profits are up over 13% in the past nine months, and were only briefly higher in the period just before oil prices collapsed. Note also that profits have tripled in the past 16 years, over which period the S&P 500 rose only about 50%.

The chart above compares this same measure of profits to nominal GDP. For the past 70 years or so, profits have averaged just over 6% of GDP. Today they stand at 8.5%. (The y-axes of the above graph are set so that the red and blue lines intersect when profits are equal to 5% of GDP.) For years, stock market skeptics have argued that profits were mean-reverting, and would inevitably fall from the 8-9% levels relative to GDP that were achieved in late 2009 and early 2010. That has not happened. I've theorized for years that profits can sustain a level relative to GDP that is higher than what we saw prior to the late 1990s because of globalization: U.S. firms are now able to address a market that is significantly and permanently larger than it was prior to the mid-1990s. As an example, consider that since the mid-1990s, U.S. international trade has roughly doubled in size relative to GDP, from 6-7% to almost 15%.

If NIPA profits are superior to FASB profits, as Art Laffer has argued for decades, then it makes sense to use NIPA profits to calculate PE ratios. The chart above does just that, using NIPA profits as the E, and the S&P 500 index as the P. (The S&P 500 index is arguably a reliable proxy for the valuation of all U.S. corporations.) I've normalized the numbers so that the long-term average of this series is equal to the long-term average of PE ratios as calculated by Bloomberg, using adjusted FASB profits. Here we see that PE ratios are only slightly above average (17.5 vs. 16.5).

At the very least, these charts support the notion that stocks are not egregiously overvalued, as many continue to argue.

Closing the Obama Gap

Third quarter GDP growth was revised upwards slightly today, from 3.0% to 3.2%. This is encouraging, of course, but it does little to change the bigger picture, which is one of unusually slow growth. Over the past year, the economy has expanded by a very modest 1.6%, and over the past two years it has risen at a mere 1.9% annualized rate. It's managed annualized growth of only 2.1% since the recovery began in mid-2009. I can think of no better way to emphasize how painful this recovery has been than the following chart, which I have been featuring and updating regularly for many years now:

The chart above uses a semi-log scale on the y-axis to emphasize how, for 40 years, the economy has followed a 3.1% annualized real growth path, bouncing back after every recession except for the last one. Never before has the U.S. economy posted such a weak recovery and such a long period of sub-par growth. Demographics—the retirement of baby boomers—can explain some of the slow growth since late 2008, but not all of it; demographic changes take years to unfold.

What we do know is that business investment has been very weak, especially in recent years, and despite record-setting profits; jobs growth has been modest; and productivity has been miserable. At root, I believe the underlying problem has been a lack of "animal spirits," a shortfall of confidence, and the persistence of risk aversion. People have simply been unwilling to work and invest more. We also know that, beginning in 2009, the economy has been burdened by 1) an unprecedented remaking of the entire healthcare industry (Obamacare) which in turn has impacted the lives and healthcare costs of nearly everyone, 2) sweeping new regulatory burdens on the financial industry (e.g., Dodd-Frank), 3) a massive increase in government spending and transfer payments (the ARRA), 4) higher marginal tax rates on income, dividends, and capital gains, and 5) a huge increase in the federal debt burden. You don't have to have a political bias to believe that these changes could go a long way to explaining why the economy has been so weak during the Obama years.

Let's call this the Obama Gap. It's depressing because it represents a huge amount of lost income and jobs that were never created. But to look on the bright side, it is a measure of the massive amount of untapped potential in the U.S. economy. If my analysis of the economy's current malaise is correct, then if the Trump administration can succeed in rolling back the burdens heaped upon the economy in the past 8 years, the future growth potential of the U.S. economy could be enormous. For example, it would take 5% real growth per year over the next 8 years just to close the Obama Gap.

Here are some recent and encouraging developments that suggest the market is in the very early stages of anticipating the unlocking of the economy's upside potential:

I've been following this chart for a number of years, and the relatively tight relationship between the price of 5-yr TIPS and gold never ceases to amaze me. (I use the inverse of the real yield on 5-yr TIPS as a proxy for their price.) Two completely different asset classes have behaved in a similar fashion for the past 10 years! The one thing that gold and TIPS have in common is that they are both a refuge from uncertainty: gold is the classic "port in a storm," and TIPS are not only government-guaranteed but also promise protection from inflation. Both have declined in price in recent weeks, and I think that is a sign that the market is less desirous of paying for protection, and by inference, somewhat less risk averse.

The Conference Board today released their November estimate for consumer confidence, and it registered a new high for the current business cycle. Confidence is still lower than it has been during previous recoveries, but it is moving a positive direction.

Since November 4th, the Vix index has fallen from 22.5 to 12.7, and the 10-yr Treasury yield has jumped from 1.8% to 2.3%. That adds up to less uncertainty and more confidence in the economy's ability to grow. Not surprisingly, the stock market is up almost 6% over the same period.

The chart above shows that there is a decent correlation between the economy's underlying growth rate and the level of real yields on 5-yr TIPS. Real yields are up some 40 bps since November 4th, which suggests the market is pricing in a modest increase in the economy's underlying growth potential. This might be just the beginning of a significant rise in real yields, however: the chart suggests that if the economy manages to sustain 4-5% annual rates of growth, real yields could rise to 3% or more. That would further imply 5% nominal yields, assuming inflation expectations don't change much from where they are currently. If we manage to close a decent portion of the Obama Gap, then the Fed is still in the very early stages of hiking short-term rates.

Would a huge increase in nominal and real yields kill the economy? No, because yields don't cause growth; yields are driven by inflation, growth, and expectations for the future. Higher yields would be the natural consequence of stronger growth, not the enemy of growth.

Monetary policy only becomes a threat to growth when the real and nominal yield curves become flat or inverted. Flat or inverted yield curves are a sign that the market realizes that the Fed is more likely to cut rates in the future than raise them, and that in turn only happens when high real and nominal rates begin to depress economic activity. The chart above shows the current real short-term rate (red line) and the market's expectation of where real short-term rates will be in five years (blue line); it's positive, and that means the real yield curve is still upward-sloping. I wouldn't start to worry about the Fed unless and until the red line moves above the blue line—which is what happened prior to the last two recessions. We're likely still years away from that point.

Trump carrots beat Obama sticks

To paraphrase Peter Thiel, Trump's supporters take him seriously, but not literally, while Trump detractors take him literally, but not seriously. There's a lot of truth in that observation, because the more we know about Trump the more we realize that his bark is worse than his bite. He's not an inflexible ideologue; he's a businessman who wants to win. Maybe, just maybe, Trump is NOT going to start a trade war with tariffs (sticks); what if he wants instead to use carrots to boost trade and thus the economy?

Trump's interview with the New York Times yesterday is quite revealing in this regard, and very encouraging. Here's the money quote from Trump:

I got a call from Tim Cook at Apple, and I said, ‘Tim, you know one of the things that will be a real achievement for me is when I get Apple to build a big plant in the United States, or many big plants in the United States, where instead of going to China, and going to Vietnam, and going to the places that you go to, you’re making your product right here.’ He said, ‘I understand that.’ I said: ‘I think we’ll create the incentives for you, and I think you’re going to do it. We’re going for a very large tax cut for corporations, which you’ll be happy about.’ But we’re going for big tax cuts, we have to get rid of regulations, regulations are making it impossible. Whether you’re liberal or conservative, I mean I could sit down and show you regulations that anybody would agree are ridiculous. It’s gotten to be a free-for-all. And companies can’t, they can’t even start up, they can’t expand, they’re choking.

This is extremely encouraging. Obama's approach to keeping jobs in the U.S. was to penalize corporations for doing inversions. Trump's approach is to create incentives—lower taxes and reduced regulatory burdens—for corporations to relocate here, to bring jobs back. Obama preferred the stick approach, while Trump appears to favor the carrot approach. Guess which one works better? It's like with capital controls: if a country won't allow capital to leave, it will never come in the first place. The best way to attract capital is to assure the owners of capital that they can take their money out whenever they want, with no penalty, and with no losses from devaluations and/or inflation in the meantime.

Trump is a businessman, and he understands how businesses work. He understands that incentives are important. Obama never understood this, and that's one big reason why the economy has been so weak for the past 8 years. I'm starting to get very optimistic about the future.

UPDATE: Matt Ridley, always worth reading, weighs in with similar thoughts here.

Tracking Trump with themes and charts

The stock market is making new all-time highs, even as the bond market is getting crushed; 10-yr Treasury yields are up almost 100 bps since their all-time low in early July. Industrial commodity prices are on a tear, yet the U.S. dollar is gaining against almost all currencies. These seeming contradictions (Aren't higher rates supposed to be bad for the economy? Don't commodity prices usually move inversely with the dollar?) aren't a portent of doom, they're more likely symptomatic of an improving global economic outlook, led by the U.S. economy.

President-elect Trump appears to be a catalyst for the recent surge in stock prices and the dollar, since the market is right to be encouraged by the prospect of lower tax rates and less burdensome regulations if Trump gets his way (ignoring for the moment his terribly misguided trade bombast). But Trump doesn't get all the credit: the healthy trends underway today began way before Trump was even close to becoming president. As I pointed out some four years ago, and which is now clearer than ever, the Obama years have had one very positive result from the perspective of economists. They have been the equivalent of a laboratory experiment designed to answer the question "Can government spending stimulate the economy?" For decades economists have debated the value of the government spending multiplier (i.e., how many extra dollars of GDP does one dollar of additional government spending create?). Keynesians have generally argued that the multiplier was greater than one, while supply-siders have generally argued it was less than one. We now know for sure that it is less than one, and it could very possibly be negative. More government spending most probably means less economic growth.

As I argued back then, the ARRA was a disaster:

American taxpayers borrowed $840 billion only to learn that the payoff was a small fraction of the additional debt incurred. We wasted almost a trillion dollars of the economy's scarce resources, and that's a big reason why the recovery has been so disappointing. If we had instead "spent" the money on lowering tax rates for everyone (e.g., we could have eliminated corporate taxes for three years with the ARRA money spent) in order to give them a greater incentive to work and invest, the results could have been dramatically better. The tax cuts might even have paid for themselves in the form of a stronger recovery over time.

And its effects have lingered, giving us the weakest recovery on record. As I noted over two years ago, federal deficits effectively absorbed all the profits of U.S. corporations since the latter half of 2008:

Despite assurances from politicians and most economists of Keynesian persuasion, not only did the biggest and most rapid increase in our federal debt burden since WW II fail to boost the economy, it coincided with the weakest recovery in history—growth of only 2.2% per year on average. (I was among those who warned in late 2008 that this would happen, and quite a few times over the years following.) This is not a problem of not spending enough, it is a failure of ideology, and arguably the most expensive such failure in the history of the world.

In short, most of what U.S. businesses have managed to produce in the way of profits in the current business cycle expansion have been borrowed by the federal government only to be flushed down the Keynesian toilet. Starved of basic investment nutrients, the economy has been weak and the public is frustrated. A weak economy—which today is some $3 trillion smaller than it might have been with better policies—is the measure of our discontent. Weak growth is the root cause of people's frustration with trade, and the reason the recent election was all about spurning the ruling elite, who think that they can pull the policy strings and magically create growth and prosperity. Most people figure they could be working more productively, and they'd rather have a better job than more government handouts. Among other things, Hillary Clinton made the mistake of promising free college and a higher minimum wage to a public that instinctively understood that there is no free lunch.

The other really big thing that has affected the economy for years, and yet is generally misunderstood, is monetary policy, and more specifically Quantitative Easing. Most people think that QE was all about artificially lowering interest rates in order to stimulate the economy. But how is it that the Fed has purchased more than $3 trillion worth of notes and bonds since 2008, yet there has been no appreciable impact on growth or inflation?

The Fed is complicit in the public's misunderstanding, since it has falsely represented QE as "stimulus." In fact it was not stimulus at all: it was accommodation. The 2008 financial collapse struck such fear into the heart of the markets and investors that risk aversion and strong demand for money and other safe assets has been the predominant driver of market sentiment ever since. Last year I recapped this argument, noting that "QE was not about pumping money into the economy, it was all about satisfying the economy's demand for liquidity. QE was erroneously billed as "stimulative," since printing money in excess of what's needed only stimulates inflation. Instead, QE was designed to accommodate intense demand for money, without which the economy might well have stumbled." The proof is in the pudding: despite years of an unprecedented expansion of the monetary base, inflation remains relatively low. If the Fed had truly been "printing money" we would have seen much higher inflation by now. The Fed supplied the money the market needed, and interest rates fell because the economy could not manage to deliver anything resembling normal growth.

Going forward, this means that we must watch very carefully whether and by how much the public is regaining confidence and becoming less risk averse. As I've said quite a few times in recent years, the return of confidence is the Fed's worst nightmare. More confidence and less risk aversion would almost surely go hand in hand with reduced demand for money and safe assets in general. If the Fed doesn't take timely steps to offset a reduction in the demand for money (by reducing the supply of excess reserves and increasing the interest it pays on excess reserves), then inflation could come back with a vengeance.

So now we know that 1) government "stimulus" spending doesn't stimulate, especially when accompanied by rising tax and regulatory burdens, and 2) monetary "stimulus" didn't
stimulate growth, since all it did was accommodate a risk averse public with an enormous appetite for safe assets. This understanding will help us track whether President Trump is making things better and whether the Fed is going to keep the dollar strong and inflation low.

Trade policy will be very important as well, since free trade is undeniably good. Yet, thanks to Trump, free trade unfortunately has gotten a bad rap in recent years since it has been blamed for the loss of millions of jobs. Fortunately, David Malpass is a key figure in Trump's economic policy team, and I've known him for many years. He's a solid supply-sider, with plenty of public policy experience and a deep appreciation for markets. He fully understands the importance of free trade. Yesterday the WSJ excerpted some of his recent remarks on economic policy issues. On the subject of Nafta (North American Free Trade Agreement), David makes it clear that the problem with Nafta is not that it has made trade free, but that it has made trade less free:

I was there at the beginning of Nafta. The idea of Nafta was, it was supposed to be…a very clear, free-market orientation that would allow both sides of the border to do what they do best in the classical sense of more commerce. 

But as it was negotiated, year after year, special interests descended upon it. And it got thicker and thicker and thicker. This was 1989, 1990 and into 1991. It’s up to 1,200 pages and then [President George H.W.] Bush left, [President Bill] Clinton came in and added the environmental chapter and the labor chapter. 

It became this monstrously large, managed trade process that doesn’t work at all for small businesses in the U.S…. There are too many parts of it that are not working.

In other words, he wants to make "free trade" freer, not less free. This is very encouraging. If lower and flatter taxes and less regulation can boost the economy (and I'm sure they can), I'm confident that with David's help, Trump can renegotiate existing trade agreements in order to make them more free, and that in turn will help boost the economy. A stronger economy will then help absorb the millions of workers who lose their jobs to overseas competitors. To sum up: the problems associated with free trade today stem from the fact that 1) trade hasn't been as free as it should have been, and 2) the economy has been too weak to create new jobs to replace the ones lost to more efficient overseas markets.

If Trump ignores Malpass, preferring to slap punitive tariffs on China rather than negotiate better and freer trade agreements, then this won't help at all. We'll have to keep a close watch on this.

What follows are updated charts which illustrate these themes and how they are progressing.

The chart above illustrates how fear, uncertainty and doubt about the economy's strength have sparked every one of the market's downturns in recent years. The recent decline in the red line has been driven by a decline in the Vix index (the fear index) and a sharp rise in 10-yr Treasury yields (one measure of the market's confidence in the future strength of the economy). As each of these panic attacks have faded, the market has gone on to higher levels.

The CRB Metals index is up 40% over the past year, and it is up "yuge" regardless of which currency it is measured against. This strongly suggests that global economic activity is picking up.

I doubt many people are aware of this fact: excess bank reserves have fallen over 25% from their high of a few years ago. The Fed has been conducting a stealthy and sizable reduction in the amount of reserves that banks could use to exponentially increase their lending—and the money supply—if they so chose. This is an under-appreciated good development.

The current PE ratio of the S&P 500 is 20.5, according to Bloomberg, which means that the earnings yield on stocks (the inverse of the PE ratio) has fallen to just under 5%. PE ratios are meaningfully above their long-term average of 16, but the earnings yield on stocks is still significantly higher than the yield on 10-yr Treasuries (see chart above). When stocks are priced so that they yield a lot more than risk-free Treasuries, it's a good bet that the market deeply distrusts the ability of corporate earnings to sustain their current levels. (Since stocks generally have expected returns that are higher than risk-free returns, a "normal" state of affairs would have earnings yields equal to or lower than risk-free yields.) In other words, the fact that the equity risk premium is still quite positive is a good sign that risk aversion is still the order of the day in the equity market, although risk aversion does appear to be declining on the margin.

Not surprisingly, consumer confidence is only modestly above its long-term average, as the chart above illustrates. Confidence has been improving on the margin, but it is still far from what we might term exuberant.

The chart above compares the prices of gold and 5-yr TIPS (using the inverse of their real yield as a proxy for their price), both of which are considered to be "safe" assets. Gold is a classic refuge from all sorts of uncertainties, and TIPS are not only risk-free but also protected against inflation. Both have been declining on the margin, and that is a good indicator that confidence is rising and risk aversion is declining. But prices are still quite elevated from an historical perspective.

The chart above suggests that the current level of real yields on 5-yr TIPS is consistent with an expectation that real economic growth is going to be somewhere in the neighborhood of 2 - 2 ½% going forward. That's better that the growth we've seen over the past year, but still a far cry from the robust growth we enjoyed in the late 1990s. If 5-yr TIPS yields get back up to 2% I'm going to be very excited about the prospects for the U.S. economy.

The two charts above illustrate the dramatic increase in money demand over the past two decades. The amount of "money" (as defined here by M2, which is the sum of currency in circulation, time deposits, checking accounts, retail money market funds, and bank savings deposits) relative to national income has never been so high. Relative to long-term trends, there is arguably as much as $2 trillion of "extra" money in the economy today, which is another sign that risk aversion is still a big deal. Most if not all of the increase in M2 has come from an increase in bank savings deposits, which still pay almost nothing. People are holding almost $9 trillion in bank deposits these days, preferring their safety to the much higher yields available on riskier assets.

Over the past 8 years M2 has been increasing at an annualized rate of 7-8%, while nominal GDP has been increasing at about a 4% annualized rate. Relative to the size of the economy, the amount of money being held by the public has increased by over 50%. If the public should ever want to reduce its holdings of so much money, what might happen? Bear in mind that wanting to hold less money doesn't mean that money just disappears. I can reduce my holdings of money, but only if someone else increases theirs. Should the public on balance want to hold less money relative to incomes, the only way that can be accomplished is by increasing the nominal size of the economy. In short, wages and prices would have to rise if the public wants to reduce its money balances.

There's a lot of money out there that could wind up bidding up the prices of goods and services if the public were to fully regain its confidence in the future. That's a lot of inflation potential to worry about, but it only becomes a concern if confidence rises and the Fed fails to take offsetting measures (e.g., raising short-term interest rates by enough to keep the demand for bank deposits from declining). Call it the Trump Paradox, in which good news could turn out to be bad news if the Fed flubs its job.

Stay tuned.

A bond bear market is bullish for stocks

In the past week, bond yields are up sharply (and prices are down "bigly"), and that's great news for the economy and the stock market. Why? Because the market is beginning to realize that Trump means business. With the notable exception of his bizarre desire to reduce the U.S. trade deficit by increasing tariffs on imports (which would punish U.S. consumers), Trump's economic policies are a welcome breath of fresh air for an economy that has for too long been suffering from crushing tax and regulatory burdens. (As an aside, I'm hopeful that Trump's economic policy advisors, two of which I've known and respected for many years, will prevent him from making the mistake of starting a trade war.)

The bond bear market actually started just over four months ago, after 10-yr Treasury yields closed at an all-time low of 1.36% on July 8th, a crisis of sorts that was prompted by fears that "Brexit" represented a serious threat to global growth. Today the 10-yr is trading at 2.22%, almost a full percentage point higher. Over that same period, the real yield on 5-yr TIPS has jumped from a low of -0.5% to -0.06%. Nominal yields have risen more than real yields, which tells us that the market has all but abandoned its fears of deflation. Long-term inflation expectations are now a very reasonable 1.8%, up from a low of 1.4% last June. Higher real yields tell us that the market now believes growth will be stronger going forward.

Meanwhile, the dollar has risen to the top of its 2-yr trading range, and that tells us that the U.S. economy is likely to be the most attractive of the developed economies in the years ahead.

This is all very encouraging, but we're still in the early stages of what is likely to be a huge bond bear market. Why? Because confidence is on the rise and the demand for money and safe assets is beginning to decline, and that means the Fed is going to have to raise rates by more than the market currently expects if it wants to keep inflation expectations in check.

Perma-bears worry that Fed tightening and higher interest rates will surely abort any nascent economic boom, tipping us instead into another recession. They see the bond market flashing a warning: Trump wants to spend too much, and the bond market vigilantes are saying that's a bad idea. Put another way: if you thought the stock market rally of the past seven years was all a function of easy money, then today you're terrified that tighter money will be the death knell for the stock market.

In contrast, I've been arguing for years that higher interest rates won't be a problem, since they would be symptomatic of stronger growth. Higher rates won't lead to an exploding deficit, because the stronger growth that pushes interest rates higher will also work to reduce the deficit by boosting tax revenues. Interest rates have been low because the market has had a very pessimistic view of the future growth potential of the U.S. economy. The Fed has been easy not to stimulate the economy, but to offset a risk averse market's huge demand for money. Monetary tightening won't be as painful this time around, because the Fed won't be draining reserves as it has in past cycles, it will simply declare that it will pay a higher rate on bank reserves, which will be necessary to offset the market's declining demand for money.

By the same logic, Trump's tax cuts won't explode the federal deficit (which is currently a non-threatening 3% of GDP) since they will help boost growth and generate higher revenues. Consider: today's 35% corporate tax rate has failed miserably to generate revenues because corporations have refused to repatriate as much as $3 trillion in offshore profits. As a result, the government has collected 35% of nothing. Trump's plan to charge corporations only 10% on their offshore profits could generate revenues of as much as $300 billion (i.e., 10% of $3 trillion) if corporations decide that 10% is a reasonable tax to pay on overseas profits. As Art Laffer always says, if you tax something less, you can expect to get more of it.

Bond yields are rising because the market is becoming less concerned about slow growth and more confident that growth will pick up. Happily, the same thing is happening in Japan and in the Eurozone. Moreover, industrial commodity prices are up over 20% in the past year because global growth fundamentals are improving. Hooray!

Here are some charts that illustrate these points:

The chart above shows the explosive rise in 10-yr Treasury yields in the past week and since their all-time closing low last July.

10-yr yields are up over 40 bps since last Monday, but 2-yr Treasury yields are up only about 20 bps. This represents a modest steepening of the yield curve which is fully consistent with an economy that is expanding. As the second chart reminds us, yields are still extremely low from an historical perspective.

10-yr nominal yields have risen by more than their real yield counterparts, which means that inflation expectations have increased. The bond market now expects consumer price inflation to average about 1.9% over the next 10 years, which is almost exactly what it's been over the previous 10 years. Nothing wrong with that! Deflation worries have all but evaporated. This opens the door wide to a Fed decision to normalize interest rates at higher levels. Not surprisingly, the market fully expects the Fed to hike rates at its December meeting.

The chart above shows us where real short-term rates have been (the red line) and what they are expected to average over the next five years (blue line). The market only expects the Fed to raise real short-term rates from -1% to zero. That's a very modest tightening and as such poses no threat to growth. The time to worry is when current real rates exceed expected real rates (i.e., when the real yield curve is inverted, as it was prior to the last two recessions). If Trump manages to hit a growth home run with policies next year, I would expect to see real rates substantially higher than they are today, thanks to much stronger economic growth expectations.

The chart above illustrates how real yields on 5-yr TIPS tend to track the real growth trend of the economy. If economic growth picks up to 3% or better thanks to better policies, expect real yields to move substantially higher as well.

As the chart above shows, gold and TIPS prices have turned down noticeably of late, and this is a very good sign that investors are becoming less risk-averse. Less risk aversion means less demand for gold, money and safe assets, and a greater propensity to work and invest. All of which is very welcome. And likely to continue.

Bond yields in Germany are tracking those of the U.S., although they are still substantially lower. This tells us that while growth expectations are improving on both sides of the Atlantic, the Eurozone economy is still fundamentally weaker than the U.S. economy. Not surprisingly, the dollar has been outperforming the Euro.

The chart above illustrates the very strong performance of industrial commodity prices in the past year.

It's notable that commodity prices are up in all currencies, even the dollar. As the chart above shows, commodities typically tend to move inversely to the dollar. I think this tells us that rising commodity prices are a reflection of stronger global growth fundamentals, not because of a monetary reflation.

As the chart above suggests, short-term bond yields have been unusually low relative to core inflation. I think this tells us that the market has been very risk averse, willing to pay a lot for the safety of Treasuries. Risk aversion is beginning to decline on the margin, and if this continues we could see yields rise substantially over the next year. If inflation continues to run at 2% or so, 5-yr Treasury yields ought to be at least 3%. That's almost double their current yield.

The chart above shows that stocks are up on the margin because uncertainty about the future (the Vix index) has fallen while confidence in future growth (the 10-yr Treasury yield) has risen.

We're still in the early stages of what could be another big bear market for bonds, but we're also still in the early stages of Trump's policymaking process. Expect to see disappointments and positive surprises along the way—it could be a bumpy ride for a while.

Election jitters haven't derailed the economy

The elections are upon us, and the outcome seems more uncertain now than it did before. Half the electorate believes Clinton is a chronic liar and deeply corrupt; if she wins, she will almost certainly face more scandals, a potential prosecution for felony offenses, and possibly impeachment. The other half is appalled that someone as uncouth and unpredictable as Trump should have access to immense power. Whichever one wins, he or she will face an uphill battle to impose an agenda. I think Trump would be more likely to change policies for the better (with the notable exception of trade), whereas Hillary's agenda would be uniformly negative. Under Hillary, the economy would very likely continue to limp along; under Trump there is a reasonable chance the economy could strengthen. I'm not a fan of either, but I'll take my chances with Trump.

Putting that all aside, the latest readings on the economy show no signs of emerging weakness or budding strength, in spite of all the worries. It's steady and slow as she goes. To me, it's an economy that is half full rather than half empty; there is plenty of upside potential waiting to be unlocked by whomever has the right keys (i.e., pro-growth policies). Here are some recently updated charts which tell the tale:

As the election approaches, markets have become more nervous, and stock prices have fallen. Given the great degree of uncertainty that surrounds the election outcome—and the outlook for future policy shifts—it's amazing the market hasn't dropped even further. I take this as a sign that the market has been skeptical all along.

Confidence has been slowly rising from unprecedented lows throughout the current recovery, but it is still far below levels that might be termed enthusiastic. As the chart above shows, the current level of confidence is only slightly above its long-term average.

Trade has been one of the economy's most persistent soft spots for years, after experiencing explosive growth in prior decades. The latest September figures show an encouraging increase in both exports and imports.

Industrial commodity prices are up almost 20% since late last year, in spite of a modestly stronger dollar (they usually move in opposite directions). That is a good indication that global economic activity has perked up somewhat.

The American Chemistry Council's index of chemical activity is up 4.5% in the past year, and at the very least this rules out any weakening in the economy's fundamentals.

The pickup in chemical activity suggests that industrial production is likely to pick up as well in coming months, as the chart above illustrates.

The ISM service sector indices suggest that the economy continues to experience moderate growth. It's encouraging to see a bit of a pickup in the service sector of the Eurozone.

Productivity continues to be weak, and this reflects a dearth of business investment; this has been and continues to be the economy's biggest problem since 2009.

Private sector jobs growth is poking along at just over 1.5% per year. With productivity running around 0.5% this suggests the economy remains on a 2% growth trajectory.