Monday, 20 February 2017

Rising Price Inflation Expectations A Drag on Consumer Spending?

The deputy-head of investments of a large fund manager recently posted this question on Linkedin: 
The second key thing to watch for the UK this year is inflation expectations. They have been steadily rising. How much of a drag will it bring to consumer spending and what implications does it have for Monetary Policy?
Here's Sean Corrigan's reply which speaks for itself: 
How can the 'expectation' of higher prices act as a 'drag' on spending? Is the whole point not that those who think prices will rise will tend to act to buy now in anticipation of the rise, so making their expectations partly self-fulfilling? Furthermore, except when supply is curtailed, how do prices in fact rise if people are not more avidly offering their money in exchange for goods -i.e., seeking to spend more aggressively? Finally, if you are suggesting some sort of counter-intuitive short-circuit DOES indeed take place, does this ipso facto not vitiate the ludicrous idea which has so infected policy-making, that expected price falls somehow cause spending to freeze?

Saturday, 18 February 2017

On This Key Measure, US Banks Are Substantially More Fragile Today Than In 2008

As was well documented during the 2008 banking crisis, the Federal Reserve will buy nearly any securities held by banks during times of banking crisis. In this sense, it's largely irrelevant what kind of securities the banks hold. 

What's important then in assessing banks' potential liquidity is the combined value of cash (reserves) and securities the banks have relative to deposit liabilities (the money supply). Today, this ratio is substantially lower than it was on the eve of the banking crisis in September 2008. 

So, whatever you've been told about the soundness on U.S. banks, on this measure they are even more unsound today than they were back when Lehman failed. Which suggests the banking crisis could be even greater next time around. 

Two Good Reasons U.S. Stocks Are Doing Well

Reason 1: the money supply growth rate remains high. Reason 2: Interest rates remain low. Dividing the former by the latter indicates the extent of the current stimuli the two combined have on stock market prices.

As the more recent history shows, the correlation between y/y changes in the money supply divided by bond yields and stock market prices is a fairly close one. 

Not to say this is not a stock market euphoria, but there are hence indeed good reasons why stocks are doing well, for now. None of these two developments are sustainable however, which is why this bull market will end as any other bull market; with a bust.

For more on this particular topic, see: Why The Stock Market Might Move Higher In The Short Term

I explain in detail the relationships between the money supply, the business cycle, and stock market returns in my book Money Cycles - The Curse of an Elastic Money Supply.

Finance and Financial Economics: A Debate About Common Sense and Illogical Models

By Pablo Fernandez 

This document tries to answer to a frequent question of students and clients: are Finance and Financial Economics the same thing? My answer is NO: I think that they are very different, although the terms are very often confused and many Finance professor positions in many Business Schools have been filled with Financial Economists.

Two ways, among others, to see the differences: a) attend a class on “Finance for managers” taught by a sensible Finance professor and attend another taught by a “Financial Economist”; b) read a book on “Finance for managers” and another on “Financial Economics”.

Financial Economics is a subject developed by economists whose main purpose is to elaborate “models” based on unrealistic assumptions. The conclusions and predictions of the “models” have very little to do with the real world: companies, financial markets, investors, managers… the most emblematic example is the CAPM.

The most used word in the Nobel Prize lectures of Fama, Shiller, Hansen and Sharpe was “model” (513 times).

This document contains facts and some opinions held by the author. I welcome comments (disagreements, errors, anecdotes…) that will help the readers and me to better differentiate between Finance and Financial Economics.

Download the paper here.

U.S. Weekly Stock Market Valuation Indicator (as of 17 Feb 2017) - Back In 99th Percentile

This simple weekly stock market valuation indicator for the U.S. is now almost back to the 99th percentile.

As the indicator reflects stock market prices relative to the money supply and a leading economic indicator, the current reading indicates the stock market has only been valued higher on one occasion previously based on data since 1994; the period surrounding March 2000, the height of the dotcom bubble.

Note that the indicator correctly indicated the 2000 and 2007 bubbles, but that the correction following the June 2015 peak was relatively minor only short-lived. Rapid increases in bank credit was one factor acting to avert a larger correction in 2015 and 2016.

This time around however bank credit growth is contracting while loan delinquencies have been on the rise for many quarters. Betting on bank credit expansion to be the savior again might therefore currently seem like a somewhat risky bet.

Also see:

Stock Market Prices Dislocate From Bank Balance Sheets

Thursday, 16 February 2017

Money Supply Update (16 Feb-17)

The y/y growth rates for the U.S. money supply remained largely unchanged from last week and in line with the averages during the last four years or so.

The length of the current run of stable growth rates is unprecedented based on data since 1986. The slowing down in bank credit expansion shown last week could certainly soon end this run. 

Charts of The Day: Number of Months for S&P 500 P/E Ratios & Stock/Bond Ratio

Wednesday, 15 February 2017

Chart of The Day: U.S. Industrial Production - The Long View

As of January 2017

On a side note:
In January 2007, the U.S. Industrial Production Index came in at 103.1. Ten years on, the index reads 104.6 - a total increase of 1.4%. During the same period, the quantity of money increased 149.7%....

'Real Wealth' Vs. The Boom-Bust Cycle

By Frank Shostak

For many, it has now become settled wisdom that the massive monetary pumping by the US central bank during and after the 2008 financial crisis saved the US and the world from another Great Depression. Hence, the Federal Reserve Chairman at the time - Ben Bernanke (AKA "Helicopter Ben") - is considered the man who saved the world. Bernanke, in turn, attributes his actions to the writings of Professor Milton Friedman, who blamed the Federal Reserve for causing the Great Depression of the 1930s by allowing the money supply to plunge by over 30%.

The reality, however, is quite different. It is not a collapse in the money stock that sets in motion an economic slump, but rather the prior monetary pumping that undermines the economy's pool of real wealth by falsifying market signals and creating massive distortions that "prime" the economy for any subsequent reduction of the flow of credit.

Tuesday, 14 February 2017