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Seeing Reality With Gold Glasses

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March 8, 2010

The most recent report from the Bureau of Labor Statistics concerning non-farm payrolls for the month of February has surprised most people and it has left a number of commentators feeling upbeat.  Reuters had reported that “The median forecast from the ten most accurate forecasters is for payrolls to fall by 70,000.”  Nevertheless, the BLS report disclosed a figure of approximately half that much.  Only 36,000 jobs had been lost and unemployment was holding at 9.7%.   One enthusiastic reaction to that news came from the Mad Hedge Fund Trader:

While the employment rate for those with no high school diploma is 16%, the kind of worker who lost their manufacturing jobs to China, the jobless rate for those with college degrees is only 4.5%.  This is proof that the dying sectors of the US economy are delivering the highest unemployment rates, and that America is clawing its way up the value chain in the global race for economic supremacy.  It is what America does best, creative destruction with a turbocharger.  There is a third influence here, which could be huge.  The BLS only contacts existing businesses for its survey.

*   *   *

The bottom line is that payroll figures are much better than they appear at first glance.

Prior to the release of that report, many commentators had been expressing their disappointment concerning the most recent economic indicators.  I discussed that subject on March 1.  On the following day, John Crudele of The New York Post focused on the dramatic drop in the Consumer Confidence Index, released by The Conference Board — a drop to 46 in February from January’s 56.5.  Here is the conclusion Mr. Crudele reached in assessing what most middle-class Americans understand about our current economic state:

Even with the stock market still bubbling and media trying its damnedest to convince us at least a million times a day that there’s an economic recovery, the American public isn’t buying it.

*   *   *

The economy has stabilized since then, helped greatly by the fact that some wealthy people feel wealthier because of an unbelievable snap back by the stock market during 2009.  (And by unbelievable in this context I mean that what happened shouldn’t be believed as either legitimate or sustainable.)

Don Luskin of The Wall Street Journal’s Smart Money blog articulated his dissatisfaction with the most recent economic indicators on February 26.  One week later, Luskin presented us with a very informative analysis for understanding the true value of one’s investments.  Luskin spelled it out this way:

Consider stocks priced not in money, but in gold.  In other words, instead of thinking of stocks as investments you make in order to increase your wealth in dollars, think of them as something to increase your wealth in gold.  After all, you don’t want to make money for its own sake — you want the money for what you can buy with it.  Gold is a symbol for all the things you might want to buy.

*   *   *

It’s easy to track stocks priced in gold because the price of the S&P 500 and the price of an ounce of gold vary closely with one another.  As of Thursday’s close, they were only about $10 apart, with the S&P 500 at 1123, and gold at about 1133.

How about a year ago, on the day of the bottom for stocks on March 9?  That day the S&P 500 closed at 676.53.  Gold closed at 920.85.  That means that one “unit” of the S&P could have bought 73% of an ounce of gold.

Today, with stocks and gold each having risen over the last year — but with stocks rising more — one “unit” of the S&P can buy 99% of an ounce of gold.  All we have to do is compare 73% a year ago to 99% now, and we can see that stocks, priced in gold, have risen 34.9%.

A 34.9% gain for stocks priced in gold is pretty good for a year’s work.  But it’s a far cry from the 69.1% that stocks have gained when they are priced in dollars.  Do you see what has happened here?  Stocks have made you lots of dollars.  But the dollar itself has fallen in value compared to the real and eternal value represented by gold.

Here’s the most troubling part.  The entire 34.9% gain made by stocks — priced in gold, that is — was achieved in just the first five weeks of rallying from the March 2009 bottom.  That means for most of the last year, since mid-April, while it has appeared that stocks have been furiously rallying, in reality they’ve just been sitting there.  All risk, no reward.

*   *   *

So why, then, did stocks — priced in dollars, not gold — continue so much higher?  Simple:  We experienced inflation-induced growth.  Throw enough stimulus money, an “extended period” of zero interest rates from the Fed, and a big dose of government debt at the economy, and you will get some growth — and, eventually, lots of inflation.

Luskin concluded the piece by explaining that if stocks move higher while gold moves lower, we will be seeing evidence of real growth.  On the other hand, if gold increases in value while stocks go down or simply get stuck where they are, there is no economic growth.

Luskin’s approach allows us to see through all that money-printing and excess liquidity Ben Bernanke has brought to the stock market, creating an illusion of increased value.

Everyone is hoping to see evidence of economic recovery as soon as possible.  Don Luskin has provided us with the “x-ray specs” for seeing through the hype to determine whether some of that evidence is real.



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A Wary Eye On The Indicators

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March 1, 2010

The past few days brought us some observations by a number of financial commentators, who expressed concern about how our economic recovery is coming along.  Although none of the following three are ready to start sounding alarms, they all seem to share a similar tone of discouragement.

Don Luskin of The Wall Street Journal ’s Smart Money blog began his February 26 piece with an explanation of how proud he used to be about the accuracy of his May, 2009 declaration that the recession had ended.  Although he still believes that he made the right call back then, the most recent economic indicators have muddied the picture:

I made my recession end call in May because of an entirely different set of statistics, designed to be predictive rather than merely to recognize what has already happened.  What worries me is that these statistics have all started to get a little worse recently.

Luskin explained that although initial unemployment claims reached their peak in early April, the four-week moving average has risen 7 percent from where it was a few weeks ago.

Over history, upticks like that have no predictive value.  There have been many of them, and very few have led to recessions.  Still, 7% is a big reversal.  In May when I got excited about the drop in claims, that drop was only about 4%!

Luskin found another disappointing trend in the fact that earnings expectations for the S&P 500 are now growing at a much slower pace than they were in April.  Two other trends concerned him as well.  The fact that the dollar has rallied ten percent in the last couple of months raises the question whether “the fear that gripped world markets in 2008 and 2009” could be returning.  Finally, the fact that the credit spread between Treasuries and “junk bonds” is now at six percent after having been below 5%, brings a little discomfort simply because of a move in the wrong direction.  Nevertheless, Luskin is still optimistic, although his perspective is tempered with realism:

So is the economic recovery over?  I don’t think so.  I think it’s just being tested.  None of the indicators I use to detect the onset of recession are giving signals.  But it’s haunting, nevertheless.  After the horrific global recession we went through, you’d think we ought to come roaring back. We’re back, but we’re not exactly roaring.

In Sunday’s Washington Post, Frank Ahrens wrote an article discussing three indicators that “spell trouble for the recovery”.  Here’s how he explained them:

— On Wednesday, the Commerce Department reported that January new-home sales dropped 11.2 percent from December, plunging to their lowest level in nearly 50 years.

— On Tuesday, the Conference Board reported that February consumer confidence fell sharply from January, driven down by the survey’s “present situation index” — how confident consumers feel right now — which hit its lowest mark since the 1983 recession.  On Friday, the Reuters/University of Michigan consumer sentiment survey also showed a falloff from January to February.

— On Thursday, the government’s report on new jobless claims filed during the previous week shot up 22,000, which was exactly opposite of what economists predicted.  Forecasters expected new jobless claims to drop by about 20,000.

Taken together, what do these reports tell us?

We’ve got a long way to go to get out of this economic mess, and we may be actually losing a little ground.

At the conclusion of that piece, Mr. Ahrens added that another factor holding back recovery is the current state of activity in the stock market.  Investors seem to be exhibiting caution, uncertainty and “a hard-to-shake sense that we haven’t hit bottom yet”.

As I frequently point out, one of my favorite financial gurus is Jeremy Grantham of GMO.  The February 26 issue of Bloomberg Business Week featured an article by Charles Stein concerning Grantham’s career.  In the section of the piece discussing Grantham’s current outlook, we see yet another view toward a very lean, slow recovery process:

Grantham’s favorite asset class today is high-quality U.S.stocks, companies defined by high, stable returns and low debt.  The allocation fund had 31 percent of its money in that category at year-end, sometimes called blue chips, according to the GMO Web site.  In the interview, he said he expects such stocks to return an average of 6.8 percent a year over the next seven years, compared with 1.3 percent for all large-cap U.S. stocks.

Emerging-market stocks may rise about 4 percent annually in the next seven years, as investor enthusiasm for economic growth in developing countries carries the stocks to unsustainable levels, Grantham said.

“Why not go along for the ride?” he said.  The MSCI Emerging Markets Index returned an average of 22 percent in the past seven years, compared with a gain of 5.5 percent by the S&P 500 index.

U.S.government bonds will return 1.1 percent a year over the seven-year period, according to the latest GMO forecast.  The Bank of America Merrill Lynch U.S. Treasury Master Index rose 4.3 percent from 2003 through 2009.

Grantham said he expects a difficult, not disastrous, period for the economy and investments.

“It will feel like the 1970s,” he said. “One step forward, one step back.”

None of the three gentlemen whom I have quoted here are seeing visions of rainbows and unicorns in our economic future — at least not for the next few years.  Be sure to keep the opinions of these experts in mind if the cheerleading by some perma-bull, TV pundit motivates you to “get in on the ground floor of the next stock market rally”.  You could save yourself a lot of money and even more pain.



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