Ain't Nothing But Blue Skies
A guest essay in which the author suggests that even if the Fed is ready to rein in old man Greenspan… they’ve got their work cut out for them.
As an economist of the Austrian persuasion, I am always suspicious of price indexes, of any sort. They tend to represent the same degree of logical confusion you might find in measuring the biodiversity of Noah’s Ark by weighing the animals, then dividing by the number of feet.
Notwithstanding, a recent article in the NYTimes challenging the findings of the infamous Boskin commission, while long, makes interesting reading.
You may recall, the Boskin commission provided, by way of some fancy footwork with the CPI, the first statistical underpinnings for the New Era mythology of faster growth, lower inflation and hence higher productivity.
According to the Times piece, a new study sponsored by the National Academy of Sciences, and commissioned in part by the BLS itself, “raises serious questions about just how much the Boskin commission or anyone else knows about the true rate of inflation.”
The study, undertaken by a panel of 13 economists from “a wide variety of institutions” and chaired by Charles Schultze of the Brookings Institution “points out many holes in the Boskin analysis.”
“For one thing,” says the Times, “in some cases, it is likely the Bureau of Labor Statistics over-adjusts for quality, meaning inflation is too low, not too high. For another, the Schultze panel cites evidence that the Boskin commission may have overstated quality in important areas.”
Aha! The NYTimes has stumbled upon that pesky old ‘hedonic’ deflator. [Long-suffering readers of the Daily Reckoning will recognize the ‘hedonics’ deflator – which helped the BLS stretch a inch of dollar growth into a yard of ‘real’ output – from the work of Dr. Kurt Richebacher.] Using this New Era method of accounting for the increasing power of computers, government quants were able to raise the estimated ‘speed-limit’ of the economy, much to the scorn of the Bundesbank and the skepticism of the likes of Bank of England deputy Mervyn King.
‘Did Greenspan Push His Optimism About the New Economy Too Far?’ a second headline in the WSJ questions (a little belatedly for readers of these pages, perhaps…).
In this second article, the WSJ asserts that the work of several past and present Fed researchers calls the whole myth of the New Era into question. The contrast is drawn distinctly between Fed Governor Meyer’s agnosticism and Greenspan’s back-of-the-envelope, cocktail party sampling.
Still, the suasion Greenspan exerted on his pet data miners – that they dig in just the right spots to find the fool’s gold for which he was searching – did as much to bemuse his fellow Council members, suggests the WSJ.
One long-time member, the retiring Fed Governor Kelley, remembered that the Chairman’s evangelism undefined not to mention his political clout and Wall Street beatification undefined led the Fed to ‘take a bit of a risk’…and to let the theory run and ‘see if this thing is going to be real and have some legs and keep allowing us, for a while at least, to have a very strong [growth rate] and a declining inflation rate.’
After six years of accelerating malinvestment and countless financial crises (both seen and yet to come), towering levels of indebtedness, currency collapses, massive disruption in people’s lives and expectations, we discover, as Woodward told us in his barf-inducing hagiography, ‘Maestro’, the intellectually rootless Big Al had a pain in his gut… and the rest of the moral stalwarts on the Fed swallowed their objections and let him do the politically popular thing.
Dear old Ed Kelley is quoted wistfully towards the end of the Journal piece, musing “It has turned out we have had a more-severe economic cycle than I thought we would. It has so far looked more like the old days.”
(Lest you wonder why Austrian economists are so resolutely set against dishonest money and, more fundamentally, all other forms of government interference in the free market and centralized ‘planning’ of our lives, this should all be enough to persuade you to pay some heed to their arguments.)
The monetary effusions Greenspan has brought into being – in the attempt to concrete over the toxic waste left behind by the Boom – are likely to manifest themselves in sharply rising prices in the months ahead.
Take into account that net capital investment has been unremarkable in recent years – and that what little there was had been misdirected – and this looks even less like the bedrock of future prosperity than we previously suspected.
Yet… if, as both the NYTimes and WSJ pieces suggest, the Fed is similarly fretful and is [finally] getting ready to rein in old man Greenspan – perhaps not so much a lame duck, as a legless ostrich undefined they’ve got their work cut out for them:
* Stock volatilities are low undefined well below September 2000 bear market levels. Bond volatility is high, but well off the peaks, also.
* The T-Bill/EuroDollar spread is 15 basis points, versus a typical 50. Industrial bonds are back to pre-WTC levels.
* The yield curve has grown increasingly humped and convex at the front end, with implied future short-term rates back to 6.5-7.0% within three years. Implied inflation (measured as the gap between TIPS and straight Treasury yields) is up 50 points from November lows.
* And after what seems like a stumble for housing in the autumn, the desire to get out of green paper and into white clapboard may also have reasserted itself… that is, if the past two months’ 41% ascent to the highest ever levels of the MBAA mortgage purchase index is any guide.
Lastly, note that the advance-decline line for the NYSE is at a 2-year high and that the S&P earnings growth factor is still near a remarkable 6% with a GAAP p/e of 49, according to Bloomberg.
The sense of crisis undefined even with respect to Enron and Argentina – has abated.
With all that is going on… one can hardly say that investors have not been forced by 1.75% nominal rates (-2% in real terms) to whistle along with Wall Street’s favourite Depression ditty undefined ‘Blue skies, ain’t nothin’ but blue skies’ – when it comes to their 401ks.
January 02, 2002
Sean Corrigan is the founder of Capital Insight, a London-based consultancy firm which provides key technical analysis of stock, bond and commodities markets to major US, UK and European banks. Corrigan is a graduate of Cambridge University and a veteran bond and derivatives trader from the City.
We are all a year older…but neither richer nor
series of rate cuts that would take the key lending
rate from 6.5% to 1.75%.
Almost everyone was sure that rate cuts would do the
trick. The economy would not sink into recession, they
said, and stocks would go up. There hadn’t been 2 down
years in the stock market, since the ’70s…the odds
were against another losing year on Wall Street!
But by the end of the year, GDP had been shrinking
since March and stocks were lower. The Dow ended the
year down 766 points undefined or 7.1%. The Nasdaq finished
off 21%, losing about $700 billion in market
capitalization during the year.
And now, the analysts and economists who had no clue in January of 2001, are almost unanimous about what 2002 will bring: a recovery in the economy; and a bull market on Wall Street.
What if it didn’t happen that way? What if the economy didn’t recover? What if stocks went down, instead of up? What if the forecasters turned out to be as wrong this year as they were the last?
Here at the Daily Reckoning, we don’t know. But if we were Mr. Market, we’d make 2002 a losing year undefined just to see the looks on their faces.
Eric Fry on Wall Street…
– It may be a brand new year, but that’s not stopping the Wall Street crowd from telling the same old stories. Then again, who could ever tire of listening to timeless classics like, “Mr. Consumer Rescues the Economy” or “Abby and the Magic Tech Stocks?”
– Mr. Consumer – along with a technology spending revival – will lead us to recovery, or so the stories go. We here at the Daily Reckoning enjoy a feel-good story as much as anyone, but we’re afraid these hopeful tales won’t have a happy ending.
– Consumers are a little tapped-out, even if they’re putting up a good appearance for the time being. And capital investment in technology remains lackluster, at best.
– To judge from the robust price action of semiconductor stocks like Micron and of the many tech stocks that have more than doubled since late September, you’d think that a vibrant tech-spending revival is already underway.
– Think again.
– “Business investment spending [in 2001] rapidly went from boom to bust, mostly because of a plunge [in] orders for high technology equipment,” Moody’s John Lonski observes. The deepest slump ever suffered by high technology companies might be easing somewhat, he says. But high-tech equipment spending in the fourth-quarter-to-date is down a “still-woeful” 29.5% from last year’s pace.
– The problem is that US corporations suffer from too much capacity AND too much debt. Over the last five years, corporate indebtedness has swelled at more than twice the rate of GDP growth. Meanwhile, capacity utilization is plummeting, which squeezes profit margins and makes onerous little tasks like paying back debts more difficult. Economists call this sort of thing a “vicious cycle.”
– So even if Greenspan’s rate cuts make the cycle less vicious, most companies have no interest in taking on more debt to make capital improvements, at least not until capacity utilization improves. Net-net, brand new Cisco routers probably are not at the top of very many corporate shopping lists.
– “According to the president of Qwest Communications,” says portfolio manager David L. Babson, “his firm will not have to lay another foot of fiber [optic cable] for seven years. That’s excess capacity! The huge over-investment in technology equipment, stimulated by unrealistic expectations for future growth, and the large, one-shot cost of the Y2K conversion of most computer systems, has caused a huge decline in technology equipment spending this year.”
– A rapid rebound is not in the cards, say the money managers from London-based Marathon Asset Management Ltd. “It is unprecedented in our experience for a sector as overcapitalized as the technology industry to recover quickly.”
– In other words, the tech boom hasn’t finished going bust. What’s more, a boom-time mentality persists, says Marathon. Tech stocks still consume an inordinately large slice of investor mind-share. “There are still 350 technology firms covered by Merrill Lynch, 50% more than as recently as 1998.”
– Even Mr. Market, that consummate optimist himself, seems to have become a little dubious about the prospects for technology companies. Since mid-December, the Dow has gained about 1.5%, while the tech-heavy Nasdaq has dropped more than 3%. Evidently, Mr. market believes that the imminent economic recovery will be far friendlier to industrial companies than to technology companies. Mr. Market may not be omniscient, but he is capable of the random shrewd insight from time to time.
– Nvidia Corp., which makes graphics chips for Xbox, Microsoft Corp.’s new video game system, took top honors in 2001 as the S&P 500’s very best performing stock. It nearly quadrupled.
– However, if past is prologue, Nvidia’s achievement means that it may be one of the most promising short-sale candidates in 2002. For example, in 2000 the top-performing S&P 500 member was none other than Enron undefined the bankrupt Internet-stock poster child. Enron stock entered 2001 selling for more than $83. It exited the year trading at 60 cents undefined a staggering loss of more than 99%.
– Back in 1999, the number one S&P 500 stocks was Qualcomm Inc., the wireless communications company. But the stock has tumbled nearly 75% from its 1999 high. “Qualcomm achieved a bit of infamy,” Reuters reports, “after failing to achieve one of the most bullish predictions of the dot-com era.” A PaineWebber analyst said the stock would hit $1,000 a share!
– All of which reminds me of one enduring story for the ages, “Buy High, Sell Low undefined a Wall Street Tragedy.”
Back in Ouzilly…
*** I saw my first euro yesterday. Until yesterday, the euro was a paper currency without even the paper. But the cash machines began distributing them on Jan. 1. In fact, you can’t get francs any more. Too bad. I was getting used to the franc. The franc bills were a lot prettier than the new euros. They have portraits of interesting people on them undefined like Antoine de St. Exupery on the 50 franc note.
*** St. Exupery wrote the curious little story of ‘The Little Prince,’ which almost everyone who studied French has been required to read. “Once you tame a flower,” said the Little Prince, “you’re responsible for it.”
That’s all I remember from The Little Prince.
*** Will, Sophia, Maria and Jules went outside after midnight last night to light a bonfire with our family friend, Edouard. Edouard loves setting fires outside. It was the night of St. Sylvestre undefined as good an occasion as any for standing around a fire in bitter cold in the middle of the night.
“Maria,” I asked this morning, “what did you do at the bonfire last night?”
“Well, we stood around and talked.”
“What did you talk about?”