Saturday, August 31, 2019

Bonddad is Back with .... The Passive/Aggressive Investor

I'm baaaaaaaaaaaaaaaaaaaaaaaaaaaacccckk

Hey all.  This is Bonddad.  I haven't been around here in ... a really long time.  As in, there was another president the last time I posted here.   Since my last posting and this one, I've been a few places.  NDD and I were over at for a long time.  Then I migrated over to Seeking Alpha -- where I still write about the economy and economics (more on that below) -- largely because they have an exclusive author program that pays people.  And, I like money.

But ... I'm back here now -- at least for this column.

So, what is the "Passive/Aggressive" investor?  Simple: it's for people who take a hands-on (aggressive) approach to passive/index style investing.  Instead of buying a stock or a company, you buy a group of ETFs, balance them a way that you like, and leave it there until something fundamental changes to make you reallocate your portfolio.

For example, suppose we're at the beginning of an expansion.  The markets are cheap; after rallying at the end of the last expansion, bonds are probably selling off a bit.  Certain sectors (basic materials, industrials) start to look attractive because they'll start to see their profits increase with the coming economic expansion.  So, you put together a portfolio of small cap indexes (like the IWC, IWM), a few sector ETFs (like the XLB and XLI), and a broad-based emerging market ETF (like the VWO), balance it a certain way, and leave it there.

Throughout the expansion you reallocate based on economic fundamentals.  For example, about 9-12 months into the expansion, news from Asia starts to pick-up.  ISMs are rising, GDP is growing, trade in increasing and unemployment is declining.  To take advantage of this trend, you add an ETF with broad exposure to Asia.  At the same time, you think the rally in basic materials has run its course but you think consumer spending will pick-up.  So, you sell your position in XLB and buy the XLY.

About 9-12 months later, you think the rally is entering mid-life, so you want to move from small caps (like the IWC or IWM that your purchased at the beginning of the rally) to a larger cap index like the QQQ or SPY.   You also think that things are really heating up in Europe, so you add an ETF that broadly tracks that geography.

Then, when you think the rally is getting a little long in the tooth, you sell the QQQ and move to the  SPY or OEF, trading up for even larger caps.  You also sell your emerging markets and Asia exposure and buy some longer-dated bonds (which typically rally towards the end of an expansion).  You also think the consumer is getting ready to slow his spending, so you sell the XLY and buy utilities and health care (the XLU and XLV), thinking that a more defensive position is what's needed.

There are a few concepts/ideas at the core of this investment style.  First, it's slower moving.  Instead of day-trading or looking for shorter-term trades, the style is based on holding periods of at least six months and probably longer.  Second, it's intimately tied to the underlying economic data and being aware of it, because, (third) you're trading on broad investment themes rather than company-specific information.

So, what will I be covering on a regular basis?  First, I'll be looking at the performance of the following broad-based equity ETFs.

Above are a number of US based ETFs that run the gamut from small (IWC and IWM) to mid (IJH) to large (QQQ, SPY) cap US stocks.  I've also got ETFs that track Asia, Latin America, Europe, developing, and developed markets.  Finally, I've got three dividend focused ETFs to add an equity income component.

Next up are the bond market ETFs:

Like the equity ETFs, I've chosen a broad-swath of sectors that run the gamut from the US to international, from short-term corporate to junk.

I'll also be tracking the "big sectors:"

And finally, I'll by looking at the "dividend aristocrats" -- stocks that have consecutively increased their dividends for the last 25 years.  However, I look at these companies a bit differently.  Aristocrats are large companies with a very long track record.  In some cases, they've been around for over a century.  They're usually major international players with very sophisticated management.  They're not going to grow that fast, if at all.  And practically every major money manager has to buy them in some proportion.  Due to all these factors, when they hit 52-week lows (or are trading near the bottom of their respective ranges) you should consider buying them.  At that point, I think of these stocks like bonds trading below par.  I look for a strong balance sheets and cash flow to make sure the dividend payments will keep coming.  For example, right now, Exxon (XOM) is trading near a 52-week low with a yield slightly over 5% -- which looks really attractive when compared to the 10-year treasury's yield of 1.51%.  That doesn't mean I think it's a good buy; the energy sector has performed poorly over the last few years and the current outlook is questionable.  But since Exxon's trading near a 52-week low with a great yield, you could also argue that it can't get much lower.

In addition, to looking at these four investment areas, I'll also be looking at various portfolio construction ideas and concepts to give you ideas for how to put one together for yourself.  And, once, I have a basic format down I may (repeat MAY) add in a general legal section that covers high-level issues like the retirement plan mechanics, basic estate ideas concepts, and other nuts-and-bolts financial things people would need information on.

Finally, you should read this column in conjunction with my work at Seeking Alpha, because they're part of a unified set.

Most trading days I write Technically Speaking, which looks at general economic trends and day along with the US markets.  This will give you regular updates on the overall market direction.

On Friday's I write a longer Technically Speaking, which covers major international numbers and a brief economic overview of major geographic regions, a summer of major central bank activity, a US economic data summary and analysis, along with a look at the charts of the US markets.

Most weekends, I write Turning Points, which uses the Arthur Burns, Geoffrey Moore system of long-leading, leading, and coincidental data to see how close or far the US is to a recession.    

I've just started a once-a-month overview of geographic regions (starting with Asia) where I look at leading and coincidental data of major economies in each region.

In fact, all of those articles naturally feed into this column.

Any, it's good to be back. 




Weekly indicators for August 26 - 30 at Seeking Alpha

 - by New Deal democrat

My Weekly Indicators post is up at Seeking Alpha.

One of the benefits(?) of the discipline of a mechanical forecasting system is that it can be completely dissonant with what your emotions are telling you.  Right now the discipline of my long/short leading/coincident indicator system is completely at odds with the dominant DOOOM based on the yield curve inversion.

Because, while the yield curve is an important and completely valid long leading indicator, right now it is the *only one* that is negative. All the others are either positive or neutral.

As usual, clicking over and reading should not only be educational for you, but rewards me with a $ or two for my efforts.

Friday, August 30, 2019

Consumer spending, particularly on durable goods, continues to be strong

 - by New Deal democrat

Earlier this week I wrote about the state of the short leading indicators. On Monday, manufacturers new orders came in positive.

This morning, consumer spending on durable goods, as well as overall, also improved sharply:

If a consumer led recession were close at hand, I would expect consumer spending on durables to decline significantly. Obviously, that hasn’t happened.

While I am at it, here is the updated comparison of real personal consumption expenditures with real retail sales, measured YoY:

Going back over 50 years, typically the latter has both improved more earlier in the cycle, and decelerated into decline first later in the cycle. The present picture continues to be late cycle with no imminent sign of any actual downturn.

Left to its own devices, the chances of a near term recession in the economy are receding dramatically.*

*subject to the next trade war tweet

Thursday, August 29, 2019

Initial jobless claims remain steadfastly, if weakly, positive

 - by New Deal democrat

As per my usual practice for the past several months, let’s look at initial jobless claims to see if there are any signs of stress.

My two thresholds are:

1. If the four week average on claims is more than 10% above its expansion low.
2. If the YoY% change in the monthly average turns higher.

Here’s this week’s update.  
Initial jobless claims last week were 215,000. This is in the lower part of its range for the past 18 months. As of this week, the four week average is 6.5% above its recent low:

Additionally, the YoY change for the month of August as a whole (red) is -250 below where it was last year (weekly YoY change is shown in blue):

The less leading but also less volatile 4 week average of continuing claims rose slightly, and remains slightly (-2.0%) below its level of one year ago:

In summary, jobless claims have steadfastly remained positive, if very weakly so, against the toughest comparisons from one year ago. There is no imminent economic downturn so long as this remains the case.

Wednesday, August 28, 2019

The quick and dirty leading indicator watch has been stagnant for 18+ months

 - by New Deal democrat

[Note: I’ve been working on my “what leads consumer spending” opus, and as often happens, I don’t want to publish anything until I’m sure I’ve got something good - which means lots more research and saved graphs — and nothing whatsoever published! I owe you something for today, so here’s a little nugget ....]

If you want a “quick and dirty” forecast for the economy over the next 4 to 6 months, the easiest approach is to look at stocks (vis the S&P 500 index) and initial jobless claims.

I’ve been noting for awhile that initial claims have gone basically nowhere since February 2018, and this afternoon I was reminded that it was the case for stocks as well. Here’s both (claims are inverted, red). Both are normed to 100 as of the week they started to go sideways:

Both were strongly positive in 2017. But for the last 18-19 months, both have with rare exception oscillated within 5% of that initial point, with the *slightest* of positive trends. Both continue to absolutely shout “SLOWDOWN” but neither points to recession in the immediate future.

Tuesday, August 27, 2019

Consumer spending leads employment — but what leads consumer spending?

 - by New Deal democrat

One relationship I have consistently flogged for the past decade is that consumer spending leads employment.  That’s still true. Here is one of the graphs on that score going back over 50 years, the YoY% change, averaged quarterly, in real aggregate payrolls (blue) vs. real retail sales (red):



It is absolutely crystal clear that sales have consistently led total payrolls by one to two quarters. (And yet I still see people making this mistake. The other day I read an article on Seeking Alpha that claimed that consumer spending was going to do well because employment was still doing well. NOT TRUE!) 

In fact, as shown on the graphs above, a decline below zero in the YoY% change of real retail sales on a quarterly basis has been a short leading harbinger of every single recession in the past 50+ years, with only two false positives (1966 and 2002).

But, in view of the current situation, in which the long leading indicators are strongly hinting at a steep slowdown or recession ahead, what best leads consumer spending?

Over the weekend, Prof. Brad DeLong linked to the twitter thread of Fed economist Prof. Claudia Sahm in which she highlighted the role of household income expectations as measured by the University of Michigan consumer sentiment survey: Unfortunately, there’s no easy graph to look at for those, but here is the data is broken out in chart form:

[The data can be found here.] 
But is this just a case of “animal spirits?” Or are consumers reacting to real, hard data in deciding that their financial position is likely to improve, remain static, or decline in the coming months?

While there is no silver bullet, I think that consumers in the aggregate are reacting rationally to changes that they see affecting their pocketbooks. Among those changes are:
  • interest rates charged on loans
  • the tightening or loosening of lending standards
  • an increase or decrease in the underlying inflation rate that is not seen as short-term 
  • the improvement, stagnation, or decline of the “hiring” component of the jobs market (as opposed to the “firing” or overall job-leaving component)

I’ve probably downloaded about 100 graphs going through these components and more, most of which would bore you to tears. But I’ll go through some of the more salient relationships I’ve found in future posts.

Monday, August 26, 2019

Short leading indicators show slowdown, not recession (for now anyway)

 - by New Deal democrat

Amount 10 days ago, I wrote that backward revisions to adjusted NIPA corporate profits meant the long leading indicators were more negative than originally believed one year ago.  Which means that watching the short leading indicators for signs of rolling over became more important.

I took a comprehensive look at the short leading indicators late last week. This post is up at Seeking Alpha.

As always, clicking over and reading helps put a penny or two in my pocket for my efforts.


Addendum: Based on the outcome of the above post, one of the two data points I said I would particularly pay attention to this week was this morning’s durable goods reports. This came in positive as to both total new orders and “core” orders less defense and Boeing:

The YoY trend is still deteriorating, with total orders up +1% YoY, and “core” new orders down -0.5% YoY.:

“Core” orders are flat, but not suggesting recession, while manufacturers’ new orders are consistent with a recession. This does not change the conclusion of the Seeking Alpha article.


And while I am at it, the below graph of the Philly Fed state coincident indicators, which were updated last Thursday, comes by way of Bill McBride a/k/a Calculated Risk:

This is a diffusion index, showing how concentrated or widespread any weakness is. At 37 states, this shows weakness — but is equal or higher to 7 prior occasions in the past 40 years when no recession followed.

If this index were to fall to 35, the number of false positives falls to to 2 - a much stronger signal. Below 35 there is only one false positive.

Sunday, August 25, 2019

On Appeasement

 - by New Deal democrat

Sometimes on Sundays I leave the dreary world of economics behind and write of broader things.

Since most tomes covering American history have an underlying sunny optimism that is nowhere appropriate for our times, recently I’ve been reading more world history having to do with the rise of fascism or fall of democracy. Several of those books have been disappointing: they are thorough blow by blow descriptions, without organizing the material enough - or simply not including any material - to make a judgment about the underlying dynamics.

On such book is Tim Bouverie’s “Appeasement,” which as is obvious from the title, chronicle’s the UK’s, and in particular Neville Chamberlain’s, policies towards the rise of Hitler Germany in the 1930s.

There are three important issues with regard to the policy of Appeasement:

1. Was it at any point appropriate? (a question I never would have even included before reading this book)
2. Was it, at least temporarily, a necessary evil?
3. Did Chamberlain use it to “buy time” for the UK to re-arm in order to fight a war with Germany?

Only the second question gets an adequate answer from Bouverie’s book.

On the first issue, it is clear that Hitler’s initial moves into the Saarland and Rhineland, and to some extent even the Anschluss with Austria, were not opposed by either Britain or France not just because they believed they were not in a military position to do so, but also in substantial part because it was felt that Germany had an understandable grievance as to the former, and a reasonable claim for the unification of ethnic Germans as to the latter.

Since both of those acts by Germany were in direct violation of the Treaty of Versailles, it necessarily follows that by the 1930s there was a feeling on the part of Britain and France that the Treaty was indeed too draconian. As to which in a footnote on p. 46 Bouverie drops the  following bombshell:

“Keynes[‘s ‘The Economic Consequences of the Peace’] was later criticized by anti-appeasers for ... having produced ‘the Bible of the Nazi movement.’ ... [or being] one of the ‘most harmful’ books ever written. These views have been endorsed by recent scholarship which makes clear that the Treaty of Versailles was n[ot] as punitive as the Germans claimed ....”

This is quite simply a stunning, major assertion, and as the blog saying goes, “extraordinary claims require extraordinary evidence.” Bouverie produces exactly zero facts to back up this assertion. Since it completely contradicts at least an important portion of the appeasers’ initial motivations, the failure to do so is a remarkable failure by the author. After all, if the Treaty of Versaille wasn’t really so bad, why wouldn’t there be a much stronger impetus to nip any violation in the bud?

Especially since it wasn’t only Keynes who came to the conclusion that the Treaty of Versailles was a disaster. Herbert Hoover, who during World War I was personally and directly responsible for saving the lives of millions of Belgians and French in occupied German territory by organizing a massive food program that crossed enemy lines, also attended the peace conference, and also was aghast at the Carthaginian terms imposed on the civilian German populace. And Woodrow Wilson himself recoiled at the punitive terms, agreeing to the Treaty only because Lloyd George and Georges Clemenceau made sure that it was the only way he got his beloved League of Nations.

The second issue is better addressed. Unless the UK and France were willing to go against their own populations, and despite their poor preparation, Appeasement at least in the early stages was a necessary evil. While those who had read ‘Mein Kampf’ had no illusions about HItler’s aims, starting another World War without at least giving Germany a chance to demonstrate that it was acting in a good faith manner, with limited aims, was hardly an abdication of statesmanship. Only when Hitler showed that he intended to enforce his will on other states regardless of their own desires, as he first did with the Anschluss (invading Austria quickly in part to make sure that a plebiscite on the issue - that unification would likely have won - could not take place), did it become apparent that Hitler’s Nazi Germany was a malicious international actor.

But of course there were two ways of employing Appeasement. It could be one part of a dual strategy that actively pursued re-armament in case Germany was not to be trusted at the same time as Germany was being given a chance. Or it could simply be a  cowardly supplication. It seems that as originally envisioned by Britain’s Foreign Office, the first strategy was the case.

But it becomes quite clear throughout Bouverie’s book that Chamberlain proverbially “drank his own kook-aid,” believing that his own diplomatic ability (which was pitiful) would cause German grievances to be sated, and thereby ensure peace. Throughout the entire period of his Prime Ministership, Chamberlain undercut his own diplomats by signaling officially or through secret back channels that he was willing to give Germany pretty much whatever it wanted, so long as it did not affect the UK or France directly. Indeed, even *after* war was declared in September 1939, during the period of the “phony war,” Chamberlain employed back channels to signal that if Germany were willing to enter into a more permanent peace, the UK was willing to listen.

Which brings us to the third issue. There’s been a revisionist strain in the past ten years that asserts that Chamberlain was aware that war was likely, and used Appeasement to buy time so that the UK and France could be better prepared. This is an outgrowth of the “dual strategy” I mentioned above.

And here once again Bouverie’s narrative falls woefully short. Chamberlain agreed to certain re-armaments, but it is mentioned only in passing that he refused to do so at any scale that would have diverted resources from normal peacetime business (Americans would clearly recognize this as being the archetype of a country club Republican). This is a devastating point that deserved a much fuller explication. 

Further, in his concluding chapter, Bouverie only discusses the rearmament issue for three paragraphs on pp. 413-14, pointing out that the UK and perhaps even more importantly France had big advantages in 1938 if any conflict broke out along the Rhine. Further, pre-Munich, Czechoslovakia was no bantamweight. It could have tied down or at least slowed down any German advance to the East while Britain and France were attacking the Rhineland. The Soviet Union was a wild card, but it too had made commitment to Czechoslovakia. In any event, the anti-Bolshevik British Torres made no timely approaches to the Soviets.

Finally, on p. 419 - the last page of the book - Bouverie devotes a paragraph to noting that the “buying time” arguments are ex post facto, stating that Germany out-armed Britain during 1938-39, and that Chamberlain viewed Appeasement as a permanent, not temporary solution. Hence, his “reluctance to increase rearmament [even] after Munich.”

But a refutation to the “buying time” thesis demands much more than 4 paragraphs in an entire book about Appeasement. In particular all evidence of Chamberlain’s foot-dragging on rearmament after the Anschluss and after Munich deserves a much fuller examination.

In the end the book is a powerful indictment of 1930s Toryism in general. As mentioned above, not just Chamberlain but most of the party approached Nazi Germany much as a businessperson might have approached a fellow oligopolist about dividing a market. An American (FDR?) is quoted as calling Chamberlain “a City man,” and a member of his cabinet, Duff Cooper, in his memoir wrote:

“Nobody in Birmingham had ever broken his promise to [ ] Mayor [Chamberlain]; surely nobody in Europe would break his promise to the Prime Minister of England.”

With 80 years of hindsight, it is clear that the indictment of Appeasement as a failure stands. It is a shame that this book fails to adequately address two of the three central issues surrounding it.