Archive for February, 2008

• The Phillips Curve
  Eddy Elfenbein, February 21st, 2008 at 11:11 am

  I’m not much of a believer in the Phillips Curve, the trade-off between employment and inflation, but with all the stagflation talk, it’s worth taking a look.
  
  This data is from 2000 to the present. The X-axis is the unemployment rate and the Y-axis is the trailing 12-month core CPI. The arrow points to the data from January and December.
  All the data I used is from the government so consider it at your own risk. Actually, I’m rather surprised by how well the curve holds up, meaning the dots seem to run diagonally from lower right to upper left. (Well, sort of…the R-squared is 0.3734.) If we’re in stagflation, then this relationship should breakdown and the dots would start drifting to the upper right. So far, that isn’t happening.
  At least, not yet.

• How Does Inflation Impact Stock Prices?
  Eddy Elfenbein, February 20th, 2008 at 1:41 pm

  Since the market is digesting a troubling inflation report today, I wanted to look at how inflation impacts the market. I took the inflation-adjusted monthly market returns from 1925 to 2005 (thanks to my Ibbotson Yearbook), resorted them by inflation rate and look at the cumulative return by rate of inflation.
  As you might expect, high inflation is bad for equity prices. In fact, the only thing worse for stocks is deflation, which is really, really bad for stocks. Here’s my chart:
  
  Stock returns do very poorly when deflation runs over 5.6% (data points 0 to 68). After that, stocks do quite well up to an inflation rate of 3.1% (data point 490). They then slow down a bit but still climb up to an inflation rate of 5% (data point 698).
  Now the trouble starts. Above 5%, stocks flat line up to an inflation rate of 12% (remember, I’m looking at the inflation-adjusted returns). After 12%, things get very ugly and stock returns plunge.
  So inflation isn’t good for stocks, but the troubling numbers we’re seeing are still a long way from being a major problem.

• Housing Indexes
  Eddy Elfenbein, February 20th, 2008 at 12:59 pm

  Calculated Risk has a great post looking at the differences in housing price indexes. As an admitted indexaholic (my name is Eddy, and I’m…), I’m afraid I have to resign myself to the fact that it’s basically impossible to come up with one simple index of house prices.
  The Case-Shiller Index has a monthly gauge of prices in 20 major markets. There’s also a quarterly national index. Calculated Risk writes, “OFHEO covers more geographical territory, OFHEO is limited to GSE loans, OFHEO uses both appraisals and sales (Case-Shiller only uses sales), and some technical differences on adjusting for the time span between sales.”
  The numbers from Case Shiller have been much gloomier recently. The reason is that lower-priced and non-GSE homes have fallen faster, which is probably because the lending standards were questionable.
  As long as home prices were rising, all the lending problems were invisible. Now that prices are falling, the problems are accelerating. The difficulty we’re having is that we’re not exactly sure what home prices, in aggregate, are doing.

• Obamanomics
  Eddy Elfenbein, February 20th, 2008 at 12:04 pm

  Now that it’s very likely he could become president, what does Barack Obama want for his economic policy? I’m not sure if this is real policy or just pandering.

  Mr Obama’s plan would lower the corporate tax rate for companies that met criteria including maintaining their headquarters in the US, maintaining or increasing their US workforce relative to their overseas workforce, holding a neutral position in union drives among their employees and providing decent healthcare.
  The lowered rate would be paid for by the abolition of tax breaks that encourage companies to shift jobs overseas. “In the last year alone, 93 plants have closed in Ohio,” Mr Obama said. “And yet, year after year, politicians in Washington sign trade agreements that are riddled with perks for big corporations but have absolutely no protections for American workers.”
  Mr Obama’s plan met instant scepticism from otherwise sympathetic Democratic economists who said it would require a large regulatory apparatus to put into practice. They also said that companies could “game the system” by spinning off overseas subsidiaries in order to reduce the offshore-onshore workforce ratio.
  They questioned whether it was necessary to provide incentives for employers to provide health insurance since Mr Obama’s healthcare plan would already mandate them to do so. Finally, Mr Obama has already tied up the estimated $10bn (€6.8bn, £5.1bn) in revenues that would be saved from abolishing tax incentives for multinational companies that retain their profits overseas.
  “I would say that this plan is borderline unimplementable,” said a Democratic economist in Washington. “It is also puzzling. Normally presidential candidates only come up with plans that are unrealistic when they are losing. But Obama is now the favourite.”

• Defaulting Before the Resets
  Eddy Elfenbein, February 20th, 2008 at 10:23 am

  One of the big fears over the housing mess is that borrowers would default once their mortgages reset. It turns out, this is happening before the reset:

  Defaults for subprime loans issued in 2007 – none of which have reset yet – hit 11.2 percent in November. That represents perhaps 300,000 households, and is twice the default rate that 2006 loans had 10 months after being issued, according to Friedman, Billings Ramsey analyst Michael Youngblood.
  Defaults are spiking well before resets come into play thanks to the lax lending environment of the past few years. Many borrowers were approved for mortgages that they had little chance of affording, even at the low-interest teaser rates .
  “I was rather shocked by the characteristics of the 2007 loans,” said Youngblood.
  Hybrid ARMs start with very affordable fixed-rate terms of two or three years. After that, rates can jump three percentage points or more, and then re-adjust even higher every six months to a year. On a $200,000 mortgage, a reset could add nearly $400 to the monthly mortgage payment.

• Today’s Inflation Report
  Eddy Elfenbein, February 20th, 2008 at 9:55 am

  Today’s report on consumer prices shows that inflation is a still a problem. The headline rate was 0.4% and the core rate was 0.3%. Both were 0.1% above expectations.
  
  Over the last four years, the headline CPI Index has grown at a 3.3% rate. The Fed Funds rate is currently targeted at 3%.
  To put the resurgence of inflation into some perspective, here’s a look at the four-year trailing rate of the core CPI.
  
  The line is clearly moving in the wrong direction, but we’ve seen a lot worse.

• The NASDAQ Stock Market on WallStrip
  Eddy Elfenbein, February 20th, 2008 at 9:48 am

  
  The exchanges have been great stocks. NDAQ’s earnings-per-share last quarter doubled.

• A Quick Look at the Bear Market
  Eddy Elfenbein, February 19th, 2008 at 1:54 pm

  Here’s a quick look at how some indexes have fared since the beginning of 2007.
  
  Even though the stock market is down, much of the damage has been contained to banking stocks and cyclical stocks (particularly homebuilders). Consumer stock have largely been unaffected.

• Paul Krugman’s Favorite Word
  Eddy Elfenbein, February 19th, 2008 at 10:33 am

  Aaron Schiff looks at Paul Krugman’s favorite word.
  (Hat Tip: Felix Salmon)

• Rules for Sovereign Wealth
  Eddy Elfenbein, February 19th, 2008 at 10:29 am

  One of the issues in today’s market is the role of Sovereign Wealth Funds. Many of these funds are run by not-so-friendly countries and they’ve placed several sizeable investments in western firms.
  The question many governments have is, how to deal with it. We don’t know exactly what these funds are or their objectives. Since this business is inherently international, the Financial Times opines in favor or global standards of conduct.
  I think that’s a terrible idea. Unless there are anti-trust or national security concerns, the decision to sell any company should rest with the shareholders and the shareholders alone. If the great sultan of Petrostan wants to blow a few billion on some American bank that lost its shorts investing in subprime, that’s between the sultan and the shareholders.
  I also think that owning parts of the west would be beneficial for these countries. It’s harder to kill off all the infidels when they’re the ones responsible for your quarterly dividend payments.