Archive: Economy

Bottom in Housing?

US News & World Report – Breaking News, World News, Business News, and America’s Best Colleges – USNews.com
The Housing Nightmare: Will Uncle Sam help distressed homeowners—and a hard-hit economy?

I don’t know if this article will prove to be the contrary indicator on housing, but it has many of the right hallmarks: mainstream media, cover story, major yellow journalism style headline. Will we look back and mark this as the bottom in the housing market?

I’m inclined not to think so… but it definitely gives me pause for thought.

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Finding the Silver Lining in Durable Goods Orders

New orders for long-lasting U.S.-made manufactured goods fell by 5.3 percent in January, the biggest drop in five months and more than analysts expected, and a key gauge of business spending also declined, a Commerce Department report showed on Wednesday.

But the news wasn’t all bad. Some industries look like a recovery may be beginning.

Consider computers and electronic products.

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Or semiconductors.

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Or machinery.

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These changes are all based on non-seasonally adjusted data from the U.S. Census Bureau.

Topics: Computer Hardware, Durable Goods, Electronic Instruments and Controls, Semiconductors | No Comments

Risk Premia Still Widening

According to the Federal Reserve, the spread between the interest rate paid on Baa-rated corporate bonds and the 10-year Treasury continued to widen last week, to 311 basis points. The spread has seldom stayed above 300 basis points for very long, going back to 1962.

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Over the last 10 years, the Internet bust caused a couple of such spikes.

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As long as the spread continues to widen, risky assets will perform poorly. However, the abnormally high risk premia we are currently seeing indicate that longer-term investors will be paid more handsomely for accepting such risks than they have been paid on average in the past.

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Officially a Crisis

I follow the spread between BBB (the highest investment grade) corporate debt and Treasuries as a gauge of overall investor willingness or unwillingness to accept risk. Lately, investors have been less and less willing to accept risk, plowing money into Treasury bonds and lowering their yield.

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The spread is now 296 basis points, which is close enough to my 3% trigger to call this an “official” crisis. Such events tend to happen only once or twice per decade. As a general rule, they have typically signaled good times to be in risky assets such as stocks.

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No Silver Lining in Employment Report

Job Growth Numbers Send Stocks Lower – New York Times

“This is a far weaker report than we expected,” Jared Bernstein, an economist at the Economics Policy Institute, wrote in an e-mail message. “The uptick in the unemployment rate alone, which won’t be revised away, is flashing recession.”

I’ve been talking about the weaker trend in employment growth for some time.  This report didn’t help at all. The year/year gain in employment was 1.0% on the seasonally adjusted basis I find difficult to trust, and was down 0.6% on a non-seasonally adjusted basis.

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Baa/Treasury Spread Continues to Widen

I often take the pulse of risk tolerance by looking at the corporate/treasury risk premium, which is calculated on a daily, weekly and monthly basis by the Federal Reserve. (Specifically, I compare the Baa Corporate bond rate to the 10 year Treasury Constant Maturity.)A lower spread is positive for the economy and for corporate earnings, as it means companies don’t have to pay as much (relative to riskless treasuries) to borrow money that can then be invested in profitable opportunities. In effect, it lowers the bar as to what makes for a worthwhile investment. A low spread has a mixed message for stock market investing – good for earnings/economy per above, but means investors are being paid less to take risks.

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The current spread is nearly as high as that of the 1998 Russia/LTCM crisis. The truly big investing opportunities (the telecom bust, the 1987 crash) usually offer spreads above 300 basis points.

Topics: Risk Premia | No Comments

Better Odds For Risk Takers

The risk premium between investment grade corporate bonds has widened, resulting in the largest rewards for those willing to accept default risk since mid-2003. The spread is nearly as wide as it was during the 1998 Russia/LTCM crisis.

That is not to say it is a good time to buy risky assets, but it does indicate that the likely payoff for doing so is higher than normal.

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Risk premia are the extra returns investors want to receive in exchange for taking risk. There are many types of risk premia, including:

  • The higher return typically earned for tying up cash for longer periods
  • The higher return on corporate (defaultable) bonds compared to treasury bonds
  • The higher return on stocks than on bonds

Some of the risk premia are hard to measure, but based on observation I have noticed that many are correlated. Investors not wanting one type of risk often don’t want any kind of risk. As a result, I often take the pulse of risk tolerance by looking at the corporate/treasury risk premium, which is calculated on a daily, weekly and monthly basis by the Federal Reserve. (Specifically, I compare the Baa Corporate bond rate to the 10 year Treasury Constant Maturity.)

A lower spread is positive for the economy and for corporate earnings, as it means companies don’t have to pay as much (relative to riskless treasuries) to borrow money that can then be invested in profitable opportunities. In effect, it lowers the bar as to what makes for a worthwhile investment. A low spread has a mixed message for stock market investing – good for earnings/economy per above, but means investors are being paid less to take risks.

Topics: Economy, Risk Premia | 1 Comment

Jobs Report Looks Weak to Me

All the stories about the jobs report being “in line with expectations” never mention the implications of those expectations. If people are expecting a crappy report and are right, it is still a crappy report even though it is in line with expectations.

This morning’s jobs report was one of those.

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Sources: Bureau of Labor Statistics data, Stock Market Beat math

The year/year growth in jobs, whether seasonally adjusted or not, is the weakest it has been since June of 2004 (which is when I started tracking it) and the trend is clearly weakening.

Topics: Economy, Employment | 1 Comment

Update on Risk Premia

A reader emailed me saying “Could you send me an update on the risk premium vs. equity prices? I am quite intrigued by this subject in light of the current divergence in equity and bond prices.”  Happy to oblige an interested reader, I also thought I should post an update for all to see.

Risk premia are the extra returns investors want to receive in exchange for taking risk. There are many types of risk premia, including:

  • The higher return typically earned for tying up cash for longer periods
  • The higher return on corporate (defaultable) bonds compared to treasury bonds
  • The higher return on stocks than on bonds

Some of the risk premia are hard to measure, but based on observation I have noticed that many are correlated. Investors not wanting one type of risk often don’t want any kind of risk. As a result, I often take the pulse of risk tolerance by looking at the corporate/treasury risk premium, which is calculated on a daily, weekly and monthly basis by the Federal Reserve. (Specifically, I compare the Baa Corporate bond rate to the 10 year Treasury Constant Maturity.)

A lower spread is positive for the economy and for corporate earnings, as it means companies don’t have to pay as much (relative to riskless treasuries) to borrow money that can then be invested in profitable opportunities. In effect, it lowers the bar as to what makes for a worthwhile investment. A low spread has a mixed message for stock market investing – good for earnings/economy per above, but means investors are being paid less to take risks.

riskpremia.jpg

Since higher risk (or the perception of higher risk) lowers the price investors are willing to pay, the lower prices in turn provide the higher expected return. Note from the above graph that the risk premium spiked in 1998 (Russia/Asian/LTCM crises), which was actually a good time to buy. The premium was remarkably low in early 2000, a signal that insufficient risk was reflected in market prices. And the high premium in early 2003 marked the end of the post-bubble bust.

This summer the subprime crisis has hurt markets and boosted the premium investors require for risk to nearly the levels of the 1998 crises. The higher risk premia may indicate an opportunity to buy. Before jumping in, however, consider the longer-term history.

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Since 1970, the risk premia has ranged from 1.5% to 2.5% with the exception of a few brief occurrences. Those occurrences seem to have been the better buy or sell opportunities – and the higher the spike, the better the time to buy. The latest instance has not yet broken the 2.5% barrier (though it is close) and is still some way from the 3.0% that characterized market troughs in 1974, 1982, 1987 and 2003.

It may come down to how much of a premium a given investor requires, and whether the investor wants to wait for the once-a-decade best opportunity or take smaller opportunities when they arise, knowing that they may still be in for some short-term downside.

Topics: Economy, Risk Premia | No Comments

Employment Numbers Weaker Than Reported

According to Reuters, U.S. employers added 110,000 new jobs in September and hiring in the two previous months was revised up strongly, the government said on Friday in a report showing a more resilient labor market than previously thought.

More resilient? That’s not what the year/year growth chart is telling me.Year over year change in employment

From this perspective, it is looking less and less resilient.

Topics: Economy, Employment | No Comments