Watching Out for Europe

As I have mentioned in many posts, our country’s economic and financial future is somewhat tied to Europe. Among the best ways to measure the changing health of Europe’s condition are bond yield spreads for various governments versus the German bond yield. Germany is used as the standard to measure against because it is financially the strongest and has the most important economy in the Eurozone. Countries with bond yields much higher than Germany are considered to be in worse financial shape, and a rising spread versus the German bond yield indicates that investors perceive a country’s economic and financial condition is deteriorating.

The first chart below shows the trend in bond spreads for the European countries about which investors are most worried. The second chart shows the change in these spreads since the end of April, 2012. Greece is excluded from these charts because its yield spread and change …

Negative Economic Surprises

The Citigroup Economic Surprise Indices (CESI) are objective and quantitative measures of economic news. They measure the magnitude of difference between actual economic data releases versus the Bloomberg survey median estimates. A positive reading on an Economic Surprise Index suggests that economic releases have, on balance, been beating consensus forecasts, whereas a negative reading indicates economic data is coming in worse than has been forecasted. The charts below show CESIs for the world’s major economies as a whole, the U.S., and the Eurozone. Over the past six weeks, the CESI indexes show that the world economy is performing worst than expected.

I consider this data to be a better indication of economic health than corporate earnings reports which, by the way, are coming in at better than expected levels. Earnings estimates are often gamed. Analysts and companies sometimes reduce their earnings expectations weeks before earnings reports with the goal of …

Week in Review: 5/11/2012

Economic data reported this past week continued to send mixed signals. On the positive side, initial unemployment claims remained comfortably below 400,000 for the second consecutive week, inflation as measured by the Producer Price Index was subdued, small business sentiment regarding our economy was a bit more positive, and consumer sentiment, as measured by the University of Michigan, rose to a new post-recession high.

Some economists made positive comments about a surge in March consumer bank borrowing, which supposedly meant people were once again willing to take on debt to buy goods and services. The problem with this view is that a large chunk of that net new debt was for student loans. Universities are, therefore, happier, but these loans do little to help businesses. Having said this, however, consumers are in fact borrowing more money. So the net of the consumer loan report is positive, just not as good …

Week in Review: 5/4/2012

I must admit to being somewhat befuddled in the early part of this past week as the stock market performed very well in the face of what was, on balance, negative economic news. In general, there is not a one-to-one relationship between how the economy and the stock market behave over short time periods, so my confusion could have been chalked up to that tenuous relationship. But this past week, the data seemed to give higher credence to the notion that the economy is growing more fitfully than was thought only a few weeks ago. Given that at one point, the stock market traded at a 4-year high, my feeling was that either I was completely misinterpreting the economic tea leaves or equity investors were not paying attention.

The only significant news supporting the case for a more vibrant economy came from the April Institute for Supply Management (ISM) report. …

Month-End Observations: 4/30/2012

With the end of April, I am updating monthly charts. In addition, important quarterly (end of March) economic data is now being released. The following are some of the more interesting charts created from these data releases.

The Stock Market

Although the stock market continues in bull market mode, as measured by the S&P 500 it is about 17% over-valued. This does not mean stocks cannot rise further, but with the bull market has passed its 3-year anniversary and more than doubled. Over the next few quarters, I think any significant gains from today’s level will be driven almost completely by emotion rather than fundamental economic strength. In addition, with each push higher by the stock market, momentum has continued to wane. This can go on for a while, but is an underlying sign of a weakening bull.

There has been no significant change in what I consider to be …

Week in Review: 4/27/2012

From the standpoint of economic news, this past week was a bad one. Although new single-family home sales for March came in at a higher than expected number, the absolute level of home sales is still very low. In addition, sales of existing homes were weak in March. And when you put the two together (new+existing), the message is that the housing market is still in the doldrums.

Keep in mind when thinking about these monthly housing numbers, that activity is very seasonal and the numbers that are reported are adjusted for these seasonal swings. For, example, fewer homes are built and sold in the winter because of the weather. The seasonally adjusted numbers take this volatility into account. So, beginning in March when the weather is better the reported numbers give a better idea as to the true strength or weakness of the industry. And so far, the numbers …

We’ve Been Framed

NPR’s podcast Planet Money often has interesting insights into the world of business and economics. A recent podcast, “Why People Do Bad Things,” delved into the reason that people who you would never expect will do things they know are wrong. This being a podcast about money, the story is business-related and tells of a businessman who believed himself to be a “fundamentally good person,” but ended up perpetrating bank fraud on a fairly large scale. However, I think the concept presented in this podcast can be applied to all areas of life.

The story began describing a successful mortgage business run with the owner’s mindset that doing the right thing will produce good results. In other words, high integrity was an assumed core principal. This mindset produced good operating results for years.

A decision to grow the business, however, created unexpected financial stress at the company. The …

Week in Review: 4/20/2012

The first month of every calendar quarter is when corporations report their earnings. If you listen to the business news media, you will hear that somewhere in the vicinity of 80% of corporations that have thus far reported earnings have beat analysts’ expectations. This would be a very impressive beginning to the earnings reporting season, if it was the whole truth.

That so many companies have been able to beat Wall Street’s most recent earnings expectations is not because the world or U.S. economy is improving or corporations are doing a great job managing their businesses. The primary reason for the better than expected news is that analysts had been significantly reducing their expectations over the past few weeks. This is why in an environment in which news commentators are frothing at the mouth about the “great” earnings reports, the stock market is having trouble moving higher. So far this …

Professionals’ “Dirty Little Secret”

“Pension fund managers continue to make decisions with their eyes firmly fixed in the rear-view mirror.” – Warren Buffett

One of the few investment professionals whose reports I always read is Jeremy Grantham at GMO. Mr. Grantham has been in the investment business for a long time and is unafraid to “go against the crowd” with his opinions about the markets and economy. In his latest quarterly investment newsletter, Mr. Grantham makes some not so complimentary comments about the investment profession that, based upon my 30+ years of being in the business, I know to be true. He writes:

“The central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples’ money. The prime directive, as Keynes (John Maynard) knew so well, is first and last to keep your job. To …