Tuesday, May 27, 2014

Onward and upward

This is still the weakest recovery ever, but the economy continues to grow and conditions continue to improve. It's a sub-par recovery, as I've been predicting for the past 5 years, mainly because the private sector has been smothered by too much government spending and too many new regulatory burdens. Things could be a whole lot better, but that is no reason to be pessimistic about the future. Indeed, there are so many things that could be fixed for the better (e.g., major reform of the tax code, the reversal of Obamacare) that the case for optimism is still compelling. As I've said many times in recent years, the economy is growing in spite of all the "help" it has received from "stimulative" fiscal and monetary policy. Pessimists see it the other way around, of course, believing that if it weren't for all the government-sponsored stimulus the economy would be a total wreck.

What follows is a series of charts which make some important points about the ongoing improvement in the economy and the financial markets.

Capital goods orders have been lackluster for over a year, but today's release of April data contained some significant upward revisions to past data. A month ago, orders appeared to be essentially flat over the past year, but they now have a modest upward tilt. As the chart above shows, orders in real terms are still substantially below their 2000 high, but they are now at a new high in nominal terms. It's still the case that businesses are very reluctant to invest—despite record-setting profits—but at least we can say that investment in productivity-enhancing capital goods is expanding, albeit slowly. As an optimist, I look at this as a glass half-full: imagine how much stronger new investment could be if taxes on capital and regulatory burdens could be reduced. The November elections hold great promise for the future if they can tip the balance of policies in a more growth- and capital-favorable direction.

According to the Case Shiller data, housing prices have recovered almost half of what they lost from their pre-recession highs. The same goes for housing starts. The recovery is more modest in real terms, but it nevertheless continues. Every day the number of households suffering from negative equity declines. There is still plenty of upside potential in the housing market.

The market capitalization of global equity markets is now at a new all-time high, having gained $38 trillion from the March 2009 low. These are huge numbers, considering that the total market cap of the U.S. equity market is currently almost $23 trillion according to Bloomberg.

Pessimists don't get excited by the above chart, which shows that the implied volatility of equity options is very close to its historic lows. They worry that because the market is not very worried these days about something going wrong, it is vulnerable to bad news. As an optimistic, I prefer to think that the market is "vulnerable" to unexpected good news. Long-time readers may remember my post from August 2012, in which I posed the question "What if something goes right?" In retrospect it was quite prescient. I still think that is the right question to ask today.

The above chart of the PE ratio of the S&P 500 shows that multiples are only slightly higher than their long-term average (according to Bloomberg calculations). That lends strong support to the view that the market is far from being overly optimistic. There is still plenty of room for multiples to expand.

Consumer confidence is at a post-recession high, but as the chart above shows, it is still far below levels associated with healthy growth and widespread prosperity, such as we had in the late 1990s. Indeed, confidence today is at levels that in the past have been associated with the onset of recessions. There is still lots of room for improvement.

As the chart above shows, Eurozone equities have been rising in line with the ongoing recovery in  U.S. equities for the past two years. In fact, Eurozone equities have recorded outsized gains over the past two years: the total return on the S&P 500 is 51%, while the Euro Stoxx 50 index has posted a total return of 77%. The Eurozone may be lagging, but it is definitely improving. 

As an aside, I couldn't help but notice the proliferation of construction cranes and road repairs as we drove through almost 2,000 miles and 5 countries' worth of European countryside earlier this month. Things are definitely improving in Europe.

There will undoubtedly be setbacks along the way, but I see little reason to doubt that things can continue to improve, albeit slowly. Onward and upward.


Tom L said...

welcome back

Brian said...

Smothered by too much government spending? What does this even mean except to insert an ideological talking point? I know you are a supply sider but try to convey some sense of economic balance here. You do realize that government spending is a component of GDP right? It literally directly contributes to GDP.

"Oh help! I'm being smothered in free money from the government! Save me!"

If I was smothered in government spending I for sure wouldn't mind. I'm sure the rest of the private sector wouldn't either.

Brian said...

Also I am interested to hear how lowering taxes on capital would help spur investment. Right now with the equity markets at record highs and interest rates near record lows the cost of capital has never been lower. There is tons of liquidity sloshing around the economy just begging to be used. So how will lowering tax rates on capital help significantly?

Benjamin Cole said...

That "structural impediments"--too high taxes and regulations--hurt economic expansion is a given. Bring 'em down.

Neither the right-wing or left-wing will like what has to be cut. Cut vets, and farmers, and women' groups, and HUD-lard, and the Commerce Department, and SBA lending and if you read David Stockman on the Pentagon you will be shocked. Cut Medicare and Social Security?

Stockman points out that national security outlays, bloated at the time the Berlin Wall fell, and the USSR collapsed, are now double that bloated level, and in real terms.

The reality is, thanks to politics, structural impediments in a democracy are eternal. But they do not have to stop growth.

In the 1960s boom-times in America, the private-sector was heavily unionized, international trade and competition was limited; the financial, transportation and telecommunications industries were heavily regulated; and the top marginal income tax rate was 90 percent. The minimum wage was much higher than today, adjusted for inflation. You had Big Labor, Big Steel, Big Oil, The Big 3 (autos), Ma Bell. You had stodgy retailing, pre-Wal Mart, pre-Internet, pre-eBay, pre-Amazon, and pre-Craigslist, pre-China manufacturing platforms.

America boomed-boomed-boomed.

The difference?

Arthur Burns ran a pro-growth Fed. An expansive money supply.

In 1965 real GDP expanded by more than 8 percent!

Sad to see the anorexic Fed today, starving the US economy and asking every five minutes if inflation doesn't look fat.

Scott Grannis said...

Brian: The only government spending that counts towards GDP is direct spending on goods and services and wages and salaries of government workers. That is in turn only a fraction of the total. Most government spending, about two-thirds comes in the form of transfer payments (sending out checks to people) which do not count towards GDP.

In any event, government is a very inefficient spender of the economy's resources since it lacks the profit motive. When government spends money wastefully it is a direct drag on the economy.

As for taxes on capital: the U.S. has the highest rate of capital taxation in the developed world. That explains why so many companies have left trillions of profits overseas: they loathe the thought of paying double taxes, and at onerous rates. If you had capital to invest and you had to choose between country A where profits were taxed at 10% and country B where profits were taxed at 40%, wouldn't you rather invest in A?

Art Laffer has made famous this saying: when you tax something more you should expect to get less of it. Reducing our tax on capital would attract more investment. Taxing capital is inefficient to begin with, since it is inevitably passed on to consumers. Better to have a zero tax on capital and tax consumption instead. That way you incentivize investment, which is the essential ingredient to progress and prosperity.

Scott Grannis said...

Benjamin: don't forget the consequences of Arthur Burns' expansive monetary policy, which were 1) the huge increase in inflation and 2) the big decline in the dollar in the 1970s.

Benjamin Cole said...

Scott- Yes, Burns went too far...but the inflationary impediments of the 1960s have largely been corrected, such as unionized labor. Egads, remember fixed airline rates and stockbroker commissions? Reg U? No competition from imports?
But my point remains---we saw 8 percent real growth in 1965. So what is holding back growth now?
It is the Fed.

theyenguy said...

Welcome back.

With peak equity wealth, VT. and peak nation investment wealth, EFA, and SCZ, and credit wealth topping out in value, peak wealth, better said, peak fiat wealth, was likely achieved on May 28, 2014; this is conveyed in the chart of Call Write Bonds, CWB, that is convertible securities, topping out in value.

Now, not only is the death of currencies underway, as is seen in the Major World Currencies, and the Emerging Market Currencies, CEW, trading lower in value; the failure of credit, that is failure of trust in the Banker Regime is underway, and is seen in the Floating Rate Note, FLOT, paying 0.41%, starting to trade lower in value on May 28, 2014.

Of note, European Credit, EU, traded lower in value as Deutsche Bank posts in PDF document The eurosceptic parties increased their share substantially, but winning parliamentary representation is not equivalent to gaining actual political influence.

As currency traders force derisking out of debt trades and deleveraging out of currency carry trades, by selling the Major World Currencies, and the Emerging Market Currencies, and as the bond vigilantes force derisking out of credit investments, by calling the Benchmark Interest Rate, ^TNX, higher from 2.44%, both fiat money and fiat wealth will tumble, and democratic nation state governance crumble,

Soon, as is presented in Revelation 13:3-4, out of a global credit bust and financial system breakdown, known as Financial Armageddon, leaders will meet in summits to renounce national sovereignty, and to announce regional pooled sovereignty, and to appoint regional fascist leaders who direct regional economies in economic policies of regional economic governance, and in schemes of debt servitude, and fully birth the debt serf as the centerpiece of economic activity. Welcome to the age of diktat and the era of debt servitude.