Friday, March 10, 2017

Cyclical Mixed Signals

I have become fairly bearish.  I think unfounded fears about "asset prices" and a bifurcation between returns on real estate vs. returns on fixed income is pulling the Fed to a position that is too hawkish with rate expectations that are too high.  Stagnating growth in debt is a really bad sign when, given the current economic fundamentals, mortgage debt levels are far too low.

That being said, the employment flows data is looking pretty upbeat.  Flows from unemployed to employed have recovered quite nicely.  And, I must admit that flows look a lot like 1999, when the Fed was raising rates, but economic expansion was pulling economic growth along, and long term rates were rising right along with short term rates.

Eventually, long term rates reversed and a correction followed in 2000.  So, I think the direction of long term rates is a decent bellwether of the direction of economic activity.  And, this has been mixed lately too, with rates rising late last year and then generally levelling off.  The sharp rise in sentiment in several surveys can't be ignored.

So, it seems we remain in a holding pattern.  I don't think that the risk/reward of positioning for a contraction is worth it, and it still seems too early to commit to positions that will gain from falling interest rates or from an eventual rebound.  It would be highly unusual at this point, I think, to see multi-year double-digit equity gains.  So, I don't see a lot of risk with being defensive.  I suppose there are idiosyncratic plays that will perform well, but this seems like a time where dry powder has its own value.

I haven't touched on unemployment duration data for a while.  Long duration unemployment continues to slowly recede, providing some ammunition for continued extra growth potential.  Before the Great Recession, we might have expected long term unemployment to be at about 1.2 million now, instead of 1.8 million.  Inferring from the BLS's median and average duration statistics, it seems as though that is basically where we stand now.  There are probably about 1.2 million workers who have been unemployed for longer than 26 weeks, who are re-entering the labor force at a typical rate.  Then, there are about 600,000 unemployed workers who have been unemployed for a very long time - more than 18 months, typically - who still identify as unemployed and in the labor force.  I wonder how much of that is related to the continued depression level residential construction activity.  I don't see a groundswell of support for solving that problem, so if that is the cause of the persistent long term UE problem, then it probably isn't going away in any case.

So, we seem to be at "full employment", with a persistent long term unemployed population that continues to decline at maybe 100,000 to 200,000 per year.  I'm not sure if that is enough of a boost to employment growth to make much difference.

Mixed signals again.


  1. I'm glad you mentioned long rates. My recommendation to the Fed would be to not raise its Fed funds rate until the 10 year was over 3.00%. I can't believe that a sub 3.00% rate will be consistent with healthy NGDP growth over the longer term.

    1. Yeah. It's strange though. We have implemented a new housing regime where there is an arbitrary limit on real growth in residential investment. That will keep rates low. I suppose, under that regime, there could be "overheating" at low real growth rates, with high inflation, mostly coming from shelter inflation, which I guess might call for tightening, if that's the world we have decided to live in. This weird regime we have now, where tax and regulatory policy pushes low income households out of ownership and into less housing consumption while it encourages high income households to increase housing consumption has to create some odd cyclical outcomes. I'm not sure I have thoroughly thought through what those implications are. Someone should. It sure seems like it would make cyclical expansion inequitable.

  2. Great wrap-up.

    Verily, the easy money in equities has been made, and in real estate.

    And since I more or less believe in EMH, tough to advise "being in the stock market" now. But then bonds do not look great either.

    From 2008 to 2016 was a great time to be an investor. How is that for hindsight? A replay appears unlikely.

    The kinds of changes needed to being about another sustained bull market appear unlikely. Tax reform, and unzoning property and reducing the state.

    So, I think in general, I agree with Kevin Erdmann, meaning my biases have been confirmed. There is more downside risk now than upside gain on the table. It it is a poker game, a good time to leave the table wait for the next serious bust or downturn.

    Maybe go into hands-on idiosyncratic property development, or VC (if you can pick good VC). Perhaps the ETF of another nation somewhere is worth a look.

  3. Mortgage debt as a % of real estate or as a % of net worth is at (or even above) long-term average. I simply don't see the case for more. And yes, I know you've spent a lot of time trying to convince us...I just dont see it (I also think that if there were a compelling case the market would figure it out..Blackstone alone has $110 of dry powder).

  4. @Ben, I too see myself as an EMH guy. So I'm holding my breath and sticking with the same bond/stock/cash allocation that I've used for the last 25 years (very slightly adjusted to reflect that I'm older). Walking away from the table and waiting for the next serious bust doesn't seem like EMH to me. While I have some sympathy for your analysis and view, my EMH mindset is keeping me steady. Note too that in 1987 (5 years into a rising market) or 1994 (12 years in), it probably felt to many investors like they missed the run up. In fact, Robert Shiller started giving his speech about Irrational Exuberance in 1995. Really really lucky for him that he didn't put it into a book until 2000.