A whiff of deflation

Every so often, and typically at three in the morning, you wake to hear a beeping noise. Sometimes it’s the battery in your smoke detector, calling sad attention to its demise. Sometimes it’s some other electronic warning or even, perhaps, an Eviltron, a tiny device that emits random beeps just to annoy its victims. At any rate, an indicator released today just set off one of those faint warnings.

Idavet’s the Chicago Purchasing Managers Index, produced by the Institute for Supply Management. The indicator is based on a monthly survey of — you guessed it — purchasing managers across the country. The index is a diffusion indicator: A reading above 50 means the economy is in expansion, while below 50 indicates contraction.

Unfortunately, the Chicago PMI walked off a cliff, falling 5.7 points to 48.7 in September. Just to pick a few bits from the unusually gloomy report released today:

  • Production led the decline with a sharp double-digit drop that placed it at the lowest since July 2009.
  • New Orders also fell significantly and both key activity measures are running well below their historical averages.
  • Just under 30% of the panel said China’s economic woes had a greater impact on them than the problems faced by the European Union.

The quote from Chief Economist of MNI Indicators Philip Uglow was also unsettling. “While activity between Q2 and Q3 actually picked up, the scale of the downturn in September following the recent global financial fallout is concerning. Disinflationary pressures intensified and output was down very sharply. We await the October data to better judge whether this was a knee jerk reaction and there is a bounceback, or whether it represents a more fundamental slowdown.”

The indicator is particularly worrisome for the Federal Reserve, which has been trying to combat deflation for the past decade. Mostly this has been felt in falling wages: If you were laid off during the financial crisis of 2007 to 2009, it’s likely that your new job offered worse benefits and lower pay. And the current trend of the so-called “gig economy” often has even lower pay and no benefits.

When wages fall, debt becomes more and more onerous. Your best bet, absent getting a raise, is to pay off debt and decrease spending. Unfortunately, cutting spending puts further downward pressure on prices — which, in turn, puts further downward pressure on wages. As bad as a wage-price upwards spiral is, a downwards spiral is even worse. Ask someone who has lived through the Great Depression, or re-read The Grapes of Wrath.

The most tangible display of deflation is through commodity prices — and not just oil, which is an outrageously rigged market that the Fed can’t really tamper with. But prices of other major commodities, such as copper, have been plunging as well.


The stock market chose to overlook the Chicago PMI today, instead focusing on the ADP employment report, which showed 200,000 new private sector jobs — which is a good number. But bond yields, which are only happy when it rains, moved lower. The September PMI may be a fluke, but somewhere in the depths of the Federal Reserve, a little alarm is going off.

Check in on the old folks

I was in San Juan, Puerto Rico this weekend, participating in a panel sponsored by the North American Securities Administrators Association. Hey, someone has to take the tough assignments.

20150921_094933One issue that has regulators particularly worried financial fraud on the elderly. It’s a big business: 10,000 Baby Boomers turn 65 every day, and more than half of state securities regulators’ enforcement actions involve seniors.

One of the biggest worries is for elderly investors in the early stages of mental impairment. They’re easily misled, and, because they can sense their impairment, are sometimes too trusting of others.Those who have recently lost a spouse or are socially isolated are the most vulnerable.

Other red flags include when an older person:

  • Complains that children frequently pester him to change is will, or to give money.
  • Runs of of money at the end of the month, or complains that bills are difficult to understand.
  • Says he can’t reach his adviser.
  • Complains he’s uncomfortable with a caregiver.

It doesn’t take much to stop by and check on an older person, and preventing fraud is just one reason to do so. If you’re alarmed, consider contacting your state securities administrator. You can get contact information for state securities regulators at http://www.nasaa.org. You can also get help from Adult Protective Service: www. apsnetwork.org.



A lean, mean, wealth destruction machine

One of the wonders of humanity, aside from opposable thumbs, is the ability to stick with bad decisions over a long time. And nowhere is this illustrated better than with the startling success of the ProShares Short 20+ Year Treasury ETF (TBF).

Unknown photographer, 1933
John Maynard Keynes

The fund aims to move in the opposite direction opposite of most bond funds. It’s a basic bet that interest rates will rise, because bond prices fall when interest rates rise. At the moment, it has $868 million in assets, despite having lost an average 10.82% a year since its inception in August 2009.

What’s remarkable is how much money keeps flowing into the fund. The past five years — during which time the fund has lost an average 8.75% a year — investors have poured a net $1.1 billion into the fund.

Now, betting on a rise in long-term interest rates would have made eminent sense at nearly any point in the past five years. After all, the bellwether 10-year Treasury note currently yields 2.09%, which, at least by modern standards, is lower than an ant’s sneakers. Don’t interest rates have to rise?

Sadly, no. Think of interest rates as the price of money. People demand higher interest rates when they think inflation will rise, because inflation erodes the purchasing power of money. The consumer price index, the government’s main gauge of inflation, actually fell 0.1% in August, and has risen just 0.2% the past 12 months. Strip out food and energy, and inflation is running at a modest 1.8%.

You really can’t get a good wage/price spiral going without an increase in wages, and that’s just not happening. How long could this go on? Ask someone in Japan. In the words of John Kenneth Galbraith, markets can remain irrational longer than you can remain solvent. Rather than argue with market, it’s better to take your loss and have money to fight another day


What’s the worst that could happen?

At Fred’s funeral, the minister confessed that he didn’t know Fred very well, and asked if some of the few people in the crowd could say something nice about it. No one moved. “Surely there must be someone here,” he pleaded, “that can say something nice about this man?”

Finally, a man in the back stood up. “His brother was worse,” he said.

The past few years, it’s been tough having anything good to say about emerging markets funds. The Vanguard Emerging Markets Stock Index fund, a reasonably proxy for emerging markets, has fallen 12.7%. vs. a 3% loss the Standard and Poor’s 500 stock index with dividends reinvested.

The Istanbul skyline.
The Istanbul skyline.

The long-term record isn’t great, either. Vanguard’s emerging markets fund has gained an average 5.9% a year the past 20 years, vs. an average 8.5% a year for the S&P 500. (Average annual gains mask the difference in long-term underperformance. A $10,000 investment in the S&P 500 would be $51,120 now. The same in the Vanguard Emerging Markets fund would be $31,472 — a $19,649 difference.)

That underperformance came at considerable damage to your psyche. One way to measure that is to look at a fund’s maximum drawdown — that is, the performance of the fund from top to bottom. In essence, it measures the experience of the hapless investor who bought at the top and sold at the bottom — the Joe Btfsplks of the investing world.

During the S&P 500’s worst peak-to-trough performance over the past 20 years, the index shed a harrowing 51%. How could things have gotten worse? You could have added an emerging markets fund to your portfolio. The Vanguard Emerging Markets Stock Index fund plunged 62.7% the same period. Those drops were, of course, during the financial crisis of 2007-2009.

But emerging markets routinely suffer above-average losses, because that’s the nature of markets are less liquid and transparent than those in developed markets. Let’s look at the past five years, conveniently overlooking the financial meltdown of 2007-2009. The worst drawdown for emerging markets has been 27.2%, vs. 16.3% for the S&P 500.

At least in theory, you should get more return for taking greater risk. But somewhere in that theory is a line beyond which the risk isn’t worth taking. (If there weren’t, then your best long-term investment would be lottery tickets.) Although emerging markets are cheap now, and may be interesting as an intermediate-term speculation, it’s hard to recommend them for long-term growth.


Don’t think about the Fed

The surest way to get anyone to think about elephants, the saying goes, is to sternly admonish them not to think about elephants. This week, all anyone in the markets is going to be thinking about is whether or not the Fed announce the start of a rate-rising campaign on Sept 17.

elephantCalculated Risk, a fine economics blog, thinks the Fed will pull the trigger this week, and provides a nice roundup of the evidence. The Wall Street Journal, meanwhile, notes this morning that rate hikes by other big central banks haven’t stuck. And, just to stir in a bit more uncertainty, the Federal Reserve Bank of Atlanta notes that the probability of deflation is no longer zero. 

But there are, honestly, other things going on in the world that could affect the stock market, and they’re useful to look at. For example, many people look at hedge funds as the pinnacle of money management skills. This may be true, but you have to overlook the funds’ horrific failure rate, says Larry Swedroe at ETF.com.

Approximately 30% of new hedge funds don’t make it past 36 months due to poor performance,” Swedroe writes. “Almost half of all hedge funds never reach their fifth anniversary. And only about 40% survive for seven years or longer.” And, while there’s some evidence that the very best hedge funds can stay hot for extended periods of time, good luck getting into one.

And then there’s China, the other elephant in the room. “We did analysis recently where we said, what if the Chinese economy is not growing at 7.5% or 8%, which is what they hope to do?,” bond manager Jeffrey Gundlach told ETF.com, “What if it’s growing at 2% or 0% instead? And we came to the conclusion that the global economic growth could very well be only 1 percent right now on an annualized basis. That’s an incredibly low rate of growth.”

And Russia. Moscow is apparently ferrying arms and soldiers to the aid of the Syrian government, flying over Iran and Iraq to do so. Other things to ponder, aside from elephants:

Did you get in on a big initial public offering this year? Why aren’t you smiling? Could it be because 40% of the $1 billion IPOs in the last 12 months are selling below their offering price?

Want to buy a new house? October is the best month.

The Bloomberg terminal, a fixture in trading rooms for three decades, is finding new competition.

Daily roundups that should be on your reading list: Barry Ritholtz’s The Big Picture, Josh Brown’s The Reformed Broker, Dealbreaker’s Opening Bell, Naked Capitalism’s links. The latter is where I found this gem: A Colorado Canyon is closed because too many people are taking selfies with bears.