Greetings from Lacunaville

SDSC_0368tarting in January, I’ve been writing full-time for InvestmentNews, doing a monthly column for Money magazine, and studying for the Certified Financial Planner mark. (This, apparently, is also a test of your prowess with a hand-held calculator). And I went to Africa.

The blog, as you may have noticed, has, um, languished. I’m hoping to revive it on a somewhat irregular basis, which, come to think of it, is pretty much its usual schedule.

I’ll be updating my links pages in the next week or so. In the meantime, here are some things to watch for today, as well as some things I’ve found interesting or peculiar.

This week, all eyes are on the Bureau of Labor Statistics’ employment situation report, out at 8:30 a.m. Friday. But the stock market seems to be resigning itself to an interest rate hike, probably in June or July. (A later hike would give the impression of a political motivation, and the Fed generally doesn’t like to do that). The current consensus estimate for new nonfarm jobs is 158,000, according to Bloomberg, with the unemployment rate falling to 5%. (And, yes, the total unemployment rate is still high, but it’s the nonfarm payrolls number that Wall Street watches.)

Wages also seem to be firming up, and it should be interesting to see if traditional summer employers, such as ice cream vendors and lawn mowers, have a hard time finding help this year. All of these would seem to give the green light to the Fed to raise rates.

Of course, we’d be talking about a lordly fed funds rate of 0.5% to 0.75% after a Fed hike, an increase that will be promptly reflected in your credit card bill and eventually in your money market mutual fund account. For those who still watch their money fund account, the average money fund now yields 0.10%, nearly triple its rate at the start of the year.

DSC_0353The stock market typically dislikes interest-rate hikes. Higher rates mean bonds become more competitive with stocks, and increase short-term borrowing rates. On the other hand, higher short-term rates mean that companies will earn somewhat more on their cash, and that savers will earn slightly more on their cash.

The old adage about Fed rate hikes — three steps and a stumble — meant that the stock market takes the first two hikes as a sign that the economy is improving, and rallies. At the third hike, stock investors realize the Fed wants the economy to slow, and stocks sell off. Bear in mind that the adage originated when a normal fed funds rate was 4% to 5%. It would take a stairway, not a few steps, to get us back to the traditional stumble level, assuming the Fed raises rates at a quarter-point a pop.

I’m an optimist, and think that rising earnings are a good thing — in fact, the one thing that the economy desperately needs for sustained growth. Most companies, despite their complaining, have nice profit margins, good balance sheets, and plenty of cash. They might even be surprised to learn that when their employees get raises, they spend more — and even on the products their employers sell.

DSC_0488The one caveat: Stocks aren’t cheap, at least by the price-to-earnings ratio of the Standard and Poor’s 500 stock index. The current PE, based on forward earnings estimates, is 17 — a tad feverish, although nothing like the levels during the technology bubble. Nevertheless, at these levels, it’s a bit like driving a bit too fast on old tires. If the market takes a rate hike really badly, investors could find that both bond and stocks slide off the road. And in that case, having a bit of cash in a money fund might be a good safeguard.


Golden slumbers

If you’ve ever looked at a St. Gaudens double eagle, you understand the allure of gold. Beautiful as it is, though, gold is a really bad thing to base your monetary system on.

Augustus St. Gaudens (1848-1907), was one of the premier artists of the Beaux-Arts generation whose works include the monument to Robert Gould Shaw and the 54th Massachusetts regiment that stands on the Boston Common. He designed the coin at the request of president Theodore Roosevelt, who wrote to his Treasury secretary,”I think the state of our coinage is artistically of atrocious hideousness. Would it be possible, without asking permission of Congress, to employ a man like Saint-Gaudens to give us a coinage which would have some beauty?”

double eagleWell, St. Gaudens certainly did. The St. Gaudens double eagle, with its figure of Liberty striding in the morning sun, is a remarkable piece of numismatic art. The coin was 90% gold and 10% copper — pure gold is too soft for coinage meant to be handled by the public — and weighed nearly an ounce. Its face value was $20.

At today’s prices, discounting for the copper, a double eagle would be worth about $944. Just as a point of reference, $20 in greenbacks from 1907 would be worth $500, according to this handy inflation calculator. 

Those who sigh for the days of hard money should sigh for beautiful coinage instead. In the first place, the free market had very little to do with the gold standard: The government set the price of gold. And from 1900 through 1933, you could always cash in a $20 bill for exactly one double eagle, because that’s the price the government set. (The government raised the price to $35 during the Depression, effectively inflating the currency).

Furthermore, the supply of gold wasn’t static, either. The government could add or decrease its gold reserves through buying it on the open market, just as the Federal Reserve can now. Big gold strikes, such as in California and Alaska, could goose the gold supply and push up inflation. And one reason for the Crash of 1857 (who can forget that?) was the sinking of the S.S. Central America, which sent 30,000 pounds of gold to the bottom of the ocean.

Being on the gold standard didn’t shield the economy from financial crises: In 1907, the same year the St. Gaudens double eagle made its debut, Wall Street had one of its most severe financial meltdowns — the “Rich Man’s Panic,” which was alleviated only by J.P. Morgan strong-arming the wealthiest men in the nation to be the lenders of last resort. The stock market fell nearly 50% in just three weeks. The experience in 1907 led to the creation of the Federal Reserve in 1913.

Finally, there’s just not enough gold in the world to go back to the gold standard. There are about 170,000 metric tons of gold in the world, according to the World Gold Council. That’s about 5.5 billion troy ounces, or $5.8 trillion. The U.S. economy is about $16 trillion — and we don’t own all the gold in the world. Either the price of gold would have to explode, or the economy would have to contract. And even then, we’d be at the mercy of gold producers in Russia and South Africa for our money supply.

I don’t have a particular opinion on the future price of gold, although it’s still above its average price of about $500 an ounce since 1974, when President Gerald Ford lifted all restrictions on the price of gold. I do think gold coins are pretty, though, and if you want to own gold, that might be the best reason.

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.

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

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, “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. 

Fear and the FOMC

The current tone on Wall Street is that the Federal Reserve will destroy all that you hold dear. Not only will the Fed raise interest rates, Janet Yellen will give your credit card number to the Russian mafia. Members of the Federal Open Market Committee will dig up your dead grandmother and kill her again. You will get chestnut blight.

Bear in mind that we’re talking about raising the federal funds rate to 0.25% from zero.

But Wall Street probably does have two things on its mind, at least when it comes to Federal Reserve policy. The first is that it’s not entirely clear that an interest rate hike would be a good idea. As Calculated Risk notes, the key sentence in last month’s statement by the powerful FOMC is this: “The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”

fourweekThe labor market has indeed been improving. The unemployment rate is 5.1%. Initial jobless claims were 275,000 the week of September 5. The four-week average rose slightly, but is still at historically low levels.

But there’s room for improvement. The total percentage of the unemployed, including those who would prefer to be working full-time but are working part-time, is still hovering around 10%. More importantly, real wages remain stubbornly low.

The other item the Fed wants to see is inflation at about 2%. Using the headline level for the Consumer Price Index, which includes food and energy, inflation is running at 0.2%. If you throw out food and energy, prices have gained 1.8% the 12 months ended July. The Fed’s own favorite inflation measure, the price index for personal consumption expenditures, has gained 0.3% the 12 months ended July.

Furthermore, a rate increase would simply propel the already strong dollar higher, which has been making other countries, most notably emerging markets, miserable. So there’s great uncertainty about whether the Fed will raise interest rates this month, and Wall Street just hates uncertainty.

The other fear is not so much a quarter-point increase in rates, which isn’t going to bankrupt anyone. Instead, it’s the notion that this is just the first in a long series of increases. All other things being equal, this means that bonds and money funds will eventually become more competitive with stocks and that Fed’s longstanding easy money policy will be over. Stocks will not only have to be the best-looking investment available, they will have to earn investors’ attention through higher earnings. And given the current level of earnings — near-record, but showing signs of slowing — that won’t be easy.