Tuesday, 21 October 2014

Charts of The Day: Falling Price Inflation Expectations in the U.S.

Monday, 20 October 2014

The Economist discovers the Entrepreneur

By Sean Corrigan

In its latest edition, in a piece entitled ‘Monetary policy: Tight, loose, irrelevant’, the ineffably dire Ekonomista considers the work of three members of the Sloan School of Management who conducted a study of the factors which – according to their rendering of the testimony of the 60-odd years of data which they analysed in their paper, “The behaviour of aggregate corporate investment” – have historically exerted the most influence on the propensity for American businesses to ‘invest’.

The article itself starts by deploying that unfailingly patronising, ‘it’s economics 101′ cliché by which we should really have long ago learned to expect some weary truism will soon be rehashed as fresh journalistic wisdom.

It may be only partly an exaggeration to say that the weekly then adopts a breathless, teen-hysterical approach to a set of results which, with all due respect to the worthies who compiled them, should have been instantly apparent to anyone devoting a moment’s thought to the issue (and if that’s too big a task for the average Ekonomista writer, perhaps they could pause to ask one of those grubby-sleeved artisans who actually RUNS a business what it is exactly that they get up to, down there at the coalface of international capitalism). Far from being a Statement of the Bleedin’ Obvious, our fearless expositors of the Fourth Estate instead seem to regard what appears to be a tediously positivist exercise in data mining as some combination of the elucidation of the nature of the genetic code and the first exposition of the uncertainty principle. This in itself is a telling indictment of the mindset at work.

Continue reading the article here.

Fed Assets and the S&P 500 (as of 17 October 2014)

As Fed assets are fast approaching 0% year on year growth, so is the the U.S. stock market as measured by the S&P 500 index. 

Saturday, 18 October 2014

The Reserve Ratio for U.S. Banks (as of 15 Oct 2014)

The reserve ratio for U.S. banks jumped to 99.2% for the week ending 15 October according to the most recent data from the Federal Reserve, up from 92.6% last week.

Friday, 17 October 2014

Four Reasons the Bernanke-Yellen Asset-Price Inflation May Be Nearing Its End

By Joseph T. Salerno

There are strong indications that the remarkable run up of asset prices in the last few years is beginning to run out of steam and may be on the verge of collapse. We will leave aside the question of whether the asset inflation is symptomatic of a garden-variety inflationary boom or is a more virulent bubble phenomenon in which prices are rising today simply because buyers anticipate that they will rise tomorrow.

Continue reading the article here.

The Short Version of the "Austrian" True Money Supply (TMS), as of 6 October 2014

The short version of the Austrian True Money Supply for the U.S., the measure of the money supply applied in this weekly report, increased 1.02% on last week for the week ending 6 October 2014. At $10.3571 trillion, a new all-time high, the money supply is now up 4.79% year to date.

The 1-year growth rate in the money supply increased to 7.36% for the week, up from 7.06% last week. The growth rate remains lower than the long term 8.30% average and also remains below the 52 week moving average of 7.85%.

In general, the conclusion remains pretty much the same as it's been during the last 14 months: money supply growth is slowing down.


With the Fed having reduced pressure on the monetary pedal during this year, it appears this combined with the slowing money supply growth rate have started spooking the U.S. stock market as the S&P 500 index is down 5.82% this month (the market might not actually be aware that the money supply directly affects stock market prices, it tends to focus on interest rates mostly in my experience). U.S. banks have expanded credit significantly for most of this year, but so far this has not been enough to push the money supply growth rate upwards (represented by the M2 money supply in the chart below).

This stock market drop has already triggered talk and speculation of whether the Fed should and will end tapering and still offer at least some QE on a regular basis going forward. It's important to remember that the U.S. economy is in a right mess with a debt to GDP ratio of around 100% (not including some huge off-balance sheet liabilities) and that budget deficits remain large ($483 bn in the fiscal year ending September 2014). In this sense, the federal government is addicted to the Fed monetizing at least part of its debt.

I see few other "saviours" for the U.S. stock market, bond prices and other asset prices than the Fed again stepping on the pedal. Short term this will help keeping asset prices at elevated, but artificial, levels. Over the medium to longer term however, it can only lead to the creation of more imbalances as pricing mechanisms are put out of action. Or will the Fed be bold, and prudent, and implement full-reserve banking? I don't know, but what I do know is that it is important to focus more on what the Fed actually does rather than speculating at what it might do. As the Fed has actually been tapering all year and as the money supply growth rate has declined combined with bubble level stock market valuations and some other very bearish signs, I've been short the U.S. stock market (and long the U.S. dollar) since the end of June this year.

Visit the short version of the Austrian True Money Supply archive here. 


I'll end this week's commentary on the Austrian true money supply with my conclusions about the U.S. stock market at the beginning of this year (click here to access the full report):

2013 was a remarkable year for U.S. equities by any standard with the S&P 500 index increasing almost 30% to record the best year for 18 years (1995). This increase was however not driven by an increase in earnings (which increased "only" 6.37% on a 10-year average basis during the year). Nor was it driven by a reduction in the 10-year treasury yield (which increased 69.54%). Rather, the price increase of the S&P 500 index was driven largely by an expansion of the P/E multiple which increased by more than 20% during the year. In addition, the S&P 500 has significantly outpaced any improvement in the real economy. For example, the S&P 500 to GDP ratio is rapidly approaching record territory:
  • The S&P 500 to 10-year average GDP ratio is now approaching the previous high from Q1 2007. 
  • The S&P 500 to 4-quarter average GDP has now surpassed the previous record from Q1 2007 though it is still lagging the all-time record high set in Q2/Q3 2000.

What then caused this expansion in the P/E multiple during the year? In my humble opinion the Fed has managed, again, to create another stock market bubble in the U.S. through flooding the market with freshly minted fiat money (by way of monetizing Federal debt). In 2013 alone, the Fed expanded its balance sheet by more than US$ 1 trillion (yes, trillion!), an increase of more than 38%. Going a bit further back to 2009, the Fed has since expanded its balance sheet by almost US$ 1.8 trillion, or more than 80%!

While the 1994 to 2000 (+185%) and 2003 to 2007 (+64%) S&P 500 stock market rallies were driven by aggressive bank credit growth (with the full support of the Fed of course, read: the taxpayer) the 2009 to 2013 (+110%) rally was driven by the Fed alone (as it is "independent", it does not have to support public spending through monetizing the Federal debt, right?). I say this because Bank Credit outstanding only increased a grand total of only about 8.5% from the end of 2008 to the end of 2013 and by only about 0.4% in 2013. This bank credit growth is very low compared to the longer term average. Since the end of 2008 however,M2 money supply outstanding increased by more than US$ 2.8 trillion, or 34% plus change. The majority of the increase in money supply starting in 2009 was hence generated by public spending monetized by the Fed rather than banks creating credit (and hence money). 

There can be no doubt that a big chunk of this new fiat money orchestrated by the Fed has eventually found its way into the U.S. stock market as reflected in an earnings yield for the S&P 500 index which is now almost 34% lower than the average since 1978. Regular readers of this blog will be familiar with this reasoning. Here's however a quick recap on the subject by professor Jesús Huerta de Soto (Money, Bank Credit, and Economic Cycles, 3rd ed, p. 461-462),
In an economy which shows healthy, sustained growth, voluntary savings flow into the productive structure by two routes: either through the self-financing of companies, or through the stock market. Nevertheless the arrival of savings via the stock market is slow and gradual and does not involve stock market booms or euphoria. 
Only when the banking sector initiates a policy of credit expansion unbacked by a prior increase in voluntary saving do stock market indexes show dramatic and sustained overall growth. In fact newly-created money in the form of bank loans reaches the stock market at once, starting a purely speculative upward trend in market prices which generally affects most securities to some extent. Prices may continue to mount as long as credit expansion is maintained at an accelerated rate. Credit expansion not only causes a sharp, artificial relative drop in interest rates, along with the upward movement in market prices which inevitably follows. It also allows securities with continuously rising prices to be used as collateral for new loan requests in a vicious circle which feeds on continual, speculative stock market booms, and which does not come to an end as long as credit expansion lasts.
When reading the above, please note that money expansion generated through the Fed monetizing government debt ultimately has an indistinguishable effect on the stock market (and other asset prices) compared to money generated through increases in bank credit.
The S&P 500 index is not the only U.S. stock market index to post a huge gain for 2013; all but one of the U.S. stock market indices I follow on a regular basis surged during the year and have climbed way above the record highs from before the collapse of Lehman Brothers in September 2008:

On average, the indices in the table above increased by 32.2% in 2013 with a median increase of 34.1%  (as of week ending 27 December), with the Wilshire US Micro-Cap Total Market Index surging a whopping 50.2%. All indices, except for the Wilshire US REIT index, are also significantly higher than their peaks prior to September 2008. Some of these all-time highs set by major stock market indices in the U.S. has led me to publish a series of "bubble charts" in recent days (e.g. here and here).
As stated above, Fed balance sheet expansion was, in my opinion, the major driver of U.S. stock market euphoria and returns in 2013. For 2014, the Fed balance sheet will increase by about 22% based on the Fed buying US$ 75 billion a month in longer term treasuries and agency mortgage-backed securities. Though a significant increase, it is nonetheless substantially lower than the 38% increase in 2013.

Therefore, unless money supply expansion generated by U.S. commercial banks picks up in 2014, the decrease in the growth rate of the Fed balance sheet combined with a significant slowdown in the growth rate of government debt (at 4.2% in Q3 2013, compared to 8.6% during the same period in 2012) will prove strong headwinds for money supply growth in 2014. And a significant reduction in money supply growth will be decisively bearish for equities. More importantly, such a slow down has been in the making for most of 2013 (e.g. see here) and if it continues the next stock market crash and so-called "financial crisis" is not too far ahead. 

In conclusion, the combination of a high stock market valuation of the S&P 500 index, record increases in all but one of the indices in the table above, the significant increase in the 10-year treasury yield since May, the low personal savings ratefinancial risk indicators hitting record lows, weak U.S. commercial banks equity to total asset ratios and a slowing down of the money supply growth rate which is already underway, means that I am now very bearish for U.S. stocks in 2014. Not to mention the debt crisis in both the U.S. and the EU (yes, they have not magically disappeared). There are simply too many indicators signalling the U.S. stock market is peaking or at least indicating a substantial probability that equities will not perform well over the next few years. In short, there is simply too much risk and too many things that could go wrong to justify being a longer term buy and hold investor in U.S. equities at this stage.

A significantly improving money supply growth rate could prove me wrong, but this would only serve to make the inevitable fall that much heavier. 


Related (my favourite video on the banking crisis and the ongoing debt crisis):

Fraud. Why The Great Recession

Thursday, 16 October 2014

ECB 2013 Accounts: Draining Ever More Resources

Right, admittedly a bit late, but here's a quick summary of the costs of running the ECB based on the 2013 accounts published in April:
  • Total administrative expenses, including depreciation, amounted to €527.370 million. This was an increase of €63.490 million, or 13.69%, on 2012. 
  • As of year end, the actual full-time equivalent number of staff holding employment contracts with the ECB was 1,790. This was an increase of 152 staff, or 9.28%, from 2012.
  • Staff costs increased from €222.374 million in 2012 to €240.524 million in 2013, an increase of €18.150 million, or 8.16%. 
  • Mr Draghi's salary increased 1.01% during the year to €378,240 (this increase must be too close to deflation for Draghi's liking).
  • Capital & Reserves in percent of Total Assets increased from 3.69% in 2012 to 4.39% in 2013, Total Assets shrunk by 15.98% while Total Liabilities shred 16.59%.
  • Gold and gold receivables declined to €14.064 billion, down from €20.359 billion in 2012.
  • Tangible and intangible fixed assets increased to €971.176 million in 2013 from €638.475 million in 2012. The increase can mostly be attributed to "Assets under construction" related to the new magnificent ECB building which presumably is expected to cost around €1.4 billion, significantly higher than the initial €850 million estimate

So, while many euro area member states are drowning in debt and high unemployment, the staff members over at the ECB and others connected to it are having a blast. Resources well spent, euro area members? 

Wednesday, 15 October 2014

The Reserve Ratio for U.S. Banks (as of 8 Oct 2014)

The reserve ratio for U.S. banks, calculated as total reserves (required + excess) in percent of M1 money supply, fell to 92.6% for the period ending 8 October. The ratio has now dropped for three consecutive weeks and it was the lowest ratio reported for 13 weeks according to the latest data published by the Federal Reserve.


U.S. Banks Are Now Operating With 100% Reserves - Is Full-Reserve Banking The Next Step?

Tuesday, 14 October 2014

CAPM: An Absurd Model

By professor Pablo Fernandez

ABSTRACTThe CAPM is an absurd model because its assumptions and its predictions/conclusions have no basis in the real world. The use of CAPM is also a source of litigation: many professors, lawyers… get nice fees because many professionals use CAPM instead of common sense to calculate the required return to equity. Users of the CAPM make many illogical errors valuing companies, accepting/rejecting investment projects, evaluating fund performance, pricing goods and services in regulated markets, calculating value creation…

According to the dictionary, a theory is “an idea or set of ideas that is intended to explain facts or events”;and a model is“a set of ideas and numbers that describe the past, present, or future state of something”. With the vast amount of information and research that we have, it is quite clear that the CAPM is neither a theory nor a model because it does not “explain facts or events”,nor does it“describe the past, present, or future state of something”.

It is important to differentiate between a fact (something that truly exists or happens: something that has actual existence; a true piece of information)and an opinion (what someone thinks about a particular thing). The CAPM could be described as anuninformed opinion,and not as asensible opinion.

We all should try to explain a portion of “the world as it is”, not of “the world according to a wrong theory” nor of “the world if men were not men”. Ricardo Yepes, professor of philosophy of my university, wrote: “Learning means being able to keep perceiving reality as it truly is: complex - and not trying to fit every new experience into a closed and pre-conceived notion or overall scheme”.

We may find out an investor’s expected IBM beta and expected market risk premium (MRP) by asking him. However, it is impossible to determine the expected IBM beta and the expected MRP of the market (for the market as a whole), because these two parameters do not exist. Different investors have different cash flow expectations and use different expected (and required) returns to equity (different expected market risk premium and different expected beta). One could only talk of the beta and the market risk premium if all investors had the same expectations. But investors do not have homogeneous expectations.

Saturday, 11 October 2014

Can Austrian Theory Help Financial Prediction?

By Peter St. Onge

A panel discussion at the 2014 Mises University addressed the question of whether Austrian economics can improve financial predictions.

We first want to distinguish between a colloquial meaning of prediction — improving the accuracy of one’s expectations — and the more rigorous sense of actually knowing the future. Austrians emphasize that the belief that one actually knows the future can be very dangerous, especially when central planners start to think their statistics and charts constitute crystal balls.

On the other hand, Austrian economists certainly predict in the more colloquial sense of improving accuracy of expectations. Indeed, Austrian economists even look both ways before crossing the street.

Read the rest here.

Something for The Week End: Dr. Israel Kirzner's Keynote Address on F. A. Hayek and the Nobel Prize

Friday, 10 October 2014

The Madness of King Fed: Asset Expansion by Year Since 2004

As of 8 October 2014

The End of The U.S. Stock Market Party

Following 78 consecutive weeks with well above average growth in Federal Reserve assets and the money supply that resulted in a 24.5% surge in the Wilshire 4500 Total Market Index, the fun has now abruptly ended. 

As of today, the growth rate in the overall monetary stimuli, measured as the combined growth rate of Fed assets and the money supply, has plummeted back to the 10.4% long term average since December 2003. By next week, chances are it will have dropped further. This decline in the growth rate has been ongoing for most of this year as the Fed has been tapering. It appears that the stock market has finally started to digest the implications of the taper as the S&P 500 has now shred more than 3% during the last month. 

The U.S. stock market party has likely ended for now and can possibly only be "saved" by the Fed reversing its existing policy or banks expanding credit aggressively (here for more). 


The U.S. Stock Market Risk Indicator, September 2014

It's The Money Supply, Stupid: 10-year Average Earnings- and Dividend Yields, S&P 500 (as of 21 Mar-14)

The Short Version of the "Austrian" True Money Supply (TMS), as of 29 September 2014

The short version of the Austrian True Money Supply for the U.S., the measure of the money supply applied in this weekly report, increased 0.18% on last week for the week ending 29 September 2014. At $10.2523 trillion, the money supply is now up 3.73% year to date.

The year on year growth rate in the money supply fell to 7.06% for the week, the lowest recorded since 31 March. This was lower than both the long term average of 8.30% since 1980 and the 7.87% average during the last 52 weeks.

The 5-year annualised growth rate in the money supply continues to drop. At 10.21%, the current growth rate was the lowest it's been for 144 weeks (week ending 26 December 2011).

The growth rate has now declined for 44 consecutive weeks, a development last seen during the 44 week period spanning 15 August 2005 to 12 June 2006.

Ever since I first started publishing this weekly report in August last year, the overall trend for the money supply growth rate has been heading down. This remains the case today as the table and chart below demonstrate. This trend will have to, ultimately, lead to certain markets and asset prices entering a less inflationary environment, in some cases leading to outright drops in prices. 

Visit the short version of the Austrian True Money Supply archive here. 


Saturday, 4 October 2014

Charts of The Day: Fed Assets and S&P 500