Well…It’s Not a Completely Jobless Recovery
Posted by Eddy Elfenbein on March 4th, 2011 at 11:55 am

Since the recession ended (yes, ended), the U.S. economy has created a grand total of 22,000 jobs.

Here’s the table from today’s nonfarm payroll report:

According to NBER, the recession ended in June 2009. Since then, the number of nonfarm payroll jobs has increased from 130,493 to 130,515.

NFP = 192,000
Posted by Eddy Elfenbein on March 4th, 2011 at 8:34 am

The employment report for February just came out. The economy created 192,000 jobs last month which was below Wall Street’s forecast of 200,000. Nonfarm payrolls for December were revised up to 152,000 from 121,000. January’s NFP was revised to up 63,000 from 36,000.

The unemployment rate ticked down to 8.9%. That’s the lowest rate since April 2009. The Wall Street Journal notes that if labor-force participation were at pre-recession levels, unemployment would be 11.5% instead of 8.9%

Private hiring, which excludes government agencies, rose by 222,000 in February, exceeding the 200,000 median forecast in the Bloomberg survey. Private payroll gains averaged 145,000 during the first two months of the year, compared with 120,000 during the last half of 2010.

Factory payrolls increased by 33,000 last month, exceeding the survey forecast of a 25,000 gain.

Service Employment

Employment at service-providers rose 122,000. Construction payrolls rose 33,000 and transportation and warehousing jobs increased by 22,000. Retail trade employment declined 8,100.

Government payrolls decreased by 30,000 last month reflecting cuts at the state and local level. Federal government employment was unchanged.

Average hourly earnings rose to $22.87 from $22.86 in the prior month, today’s report showed. The average work week for all workers held at 34.2 hours.

The so-called underemployment rate — which includes part- time workers who’d prefer a full-time position and people who want work but have given up looking — decreased to 15.9 percent from 16.1 percent.

The report also showed a decrease in long-term unemployed Americans. The number of people unemployed for 27 weeks or more was little changed as a percentage of all jobless, at 43.9 percent.

CWS Market Review – March 4, 2011
Posted by Eddy Elfenbein on March 4th, 2011 at 7:55 am

Next week, the bull market turns two years old. This has probably been the most hated rally in Wall Street history. At nearly every point, some talking head has declared that it’s a bogus rally built on cheap money.

Well…maybe. But still, the market has continued to climb higher and higher and higher. The lesson is that focusing on high-quality companies is much more profitable over the long term than is making broad pronouncements of doom.

Measuring from March 9, 2009 to Thursday, the S&P 500 has gained 96.73% (excluding dividends). That’s not a bad return for five or six years, but for two years…heavens to murgatroid, it’s pretty darn impressive. As strong as the market’s been, our Buy List has done even better. Over that same period, the Buy List is up an amazing 133.40% (that’s adjusted for rebalancing the Buy List each year).

I recently said to expect a sideways market this spring, and ever since President’s Day, that’s pretty much what we’ve seen. I don’t think we’ll see a major downturn-it will probably be closer to a range-bound market for the next few weeks. On Thursday, the S&P 500 closed at 1,330.97 which is its highest close since the mini sell-off began nearly two weeks ago. This latest swoon may already be over. We’re now less than 0.9% from making a new two-and-a-half year high on the S&P 500.

Let’s look at the positive news: The S&P 500 is still above its 50-day moving average. Historically, the market generally does well as long as we stay above the 50-DMA. On Thursday, the index closed above its 50-DMA for the 126^th trading session in a row. That’s a tie for the seventh-longest streak since 1932. The reason the streak has gone on so long isn’t merely due to rising prices, but it’s also due to low volatility. Low volatility isn’t a good thing in itself, but it’s a sign that investors aren’t as nervous as they used to be.

The stock market has also risen for both January and February. Historically, that’s a very good sign. Since 1938, the market has risen in both January and February 26 times. Every single time since then, the stock market closed higher for the next ten months of the year. The record is a perfect 26-0. The average annual gain in those years is 20.73%.

We’re also in the crucial March-April time slot which has historically been the top-performing two-month period of the year. On average, the market has risen 3.13% over these two months.

Another piece of good news is that the sell-off in the bond market seems to have cooled off. From August to February, the yield on the 30-year Treasury bond rose over 1.3%. That’s a big jump and those higher yields certainly tempted some stock investors to jump from equities into debt. Over the past three weeks, however, the yield on the 30-year has slowly climbed down. Please don’t get caught up in the endless screams about the collapse of the dollar or the prospects of hyper-inflation. These are certainly concerns, but as of right now, there’s zero evidence that the market is worried about them. Some of these guys you hear know that the crazier and more apocalyptic the predictions they make, the more attention they’ll get.

The U.S. Dollar Index is down but it’s hardly in free fall. In fact, the Dollar Index is higher than it was three years ago. A good proxy for the market’s view of inflation is the spread between the yield on the 30-year Treasury and the yield on the 30-year TIPs. Right now, the spread is about 2.5%. Historically, inflation hasn’t been a problem for stocks until it’s over 5%.

Since we’ve been focused on a business rebound, our Buy List continues to do very well. Even during this recent turbulence, the Buy List has outperformed the S&P 500 by 0.65% over the last six trading sessions. That may not sound like a lot, but it’s very good for a broadly diversified portfolio. Having said that, let me remind you that it’s very important to be well-diversified in this market. Please make sure a few different industries are represented in your portfolio.

In each issue of CWS Review, I highlight a few Buy List stocks that look especially good at the moment. Last week, I mentioned Stryker ($SYK) and I’m happy to see that the shares broke out to another two-year high. Stryker is a very solid company and it’s already a 20% winner for us this year. The stock has been on a tear since they gave very strong guidance for 2011.

Deluxe ($DLX) is one of the quieter names on this year’s Buy List, but don’t be fooled; it’s doing very well (+14.81% YTD). DLX hit a new 52-week high on Thursday as did Reynolds American ($RAI). Jos. A Bank Clothiers ($JOSB) is looking like it might be the next stock to break out.

Oracle ($ORCL)also looks very good at this price. The company will release its next earnings report on March 24. Wall Street’s current consensus is for 49 cents per share. I haven’t finalized my number-crunching, but I suspect that Oracle’s earnings will come in higher than that. Actually, it might be a lot higher. ORCL is a strong buy below $35.

Finally, Abbott Labs ($ABT) is also pretty inexpensive here. The dividend currently yields 4% which is more than a 10-year Treasury bond. In January, Abbott gave full-year guidance of $4.54 to $4.64 per share. That’s impressive growth over 2010’s EPS of $4.17. (The U.S. Treasury isn’t growing its profits like that!) I’m not sure why ABT hasn’t responded more favorably. Perhaps it will soon. Either way, ABT is a very good buy below $50 per share.

Let me caution you not to be impressed by the recent rally in gold. The fundamentals are clearly on gold’s side, meaning low real interest rates. The problem is that I don’t believe it’s a lock that those low rates will stay for a long time. It could happen, but the Fed can call off the party at anytime. It’s not a risk worth taking.

That’s all for now. Be sure to keep visiting the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

Best – Eddy

The S&P 500 Over the Last 10 Days
Posted by Eddy Elfenbein on March 4th, 2011 at 7:33 am

Here’s a look at the minute-by-minute voyage of the S&P 500 over the last two weeks. The index peaked right before President’s Day. The market fell sharply, bounced off 1,300, then fell through 1,300. We rallied last Friday, gave some back, then opened higher yesterday and continued to rally.

Morning News: March 4, 2011
Posted by Eddy Elfenbein on March 4th, 2011 at 7:13 am

Berkshire Sets Up India Insurance Distribution Unit

Korea Express Shareholders Said to Seek $1.8 Billion in Sale

Food Prices Hit Record High, Spurring Worries About Global Unrest

Gold Rises Towards $1,420/oz Ahead of U.S. Payrolls

Fed’s Lockhart Says Oil Adds ‘Caution’ to U.S. Outlook

Jobs Seen at 9-Month High in February

Payrolls Likely Rebounded as U.S. Economy, Weather Improved

Fed Policy Makers Signal Abrupt End to Bond Purchases in June

Without Loan Giants, 30-Year Mortgage May Fade Away

Wal-Mart Hikes Dividend 20.6%

Daimler Steel Headwind Saps Profit as Rubber Hits Continental AG

Goldman C.E.O. Could Testify in Galleon Trial

Market Risks Far Outweigh The Rewards

Joshua Brown: How To Beat Tooth Fairy Inflation

Gold Hits All-Time High
Posted by Eddy Elfenbein on March 3rd, 2011 at 9:27 am

The price of gold recently broke out to a new all-time high of $1,440.32. To commemorate this milestone I’m re-running of my most linked-to posts ever on a possible model for how to price gold. Jake at EconomPicData was kind enough to make a longer-term chart of our model.

One of the most controversial topics in investing is the price of gold. Eleven years ago, gold dropped as low as $252 per ounce. Since then, the yellow metal has risen more than five-fold, easily outpacing the major stock market indexes—and it seems to move higher every day.

Some goldbugs say this is only the beginning and that gold will soon break $2,000, then $5,000 and then $10,000 per ounce.

But the important question is, “How can anyone reasonably calculate what the price of gold is?” For stocks, we have all sorts of ratios. Sure, those ratios can be off…but at least they’re something. With gold, we have nothing. After all, gold is just a rock (ok ok, an element).

How the heck can we even begin to analyze gold’s value? There’s an old joke that the price of gold is understood by exactly two people in the entire world. They both work for the Bank of England and they disagree.

In this post, I want to put forth a possible model for evaluating the price of gold. The purpose of the model isn’t to say where gold will go but to look at the underlying factors that drive gold. Let me caution that as with any model, this model has its flaws, but that doesn’t mean it isn’t useful.

The key to understanding the gold market is to understand that it’s not really about gold at all. Instead, it’s about currencies, and in our case that means the dollar. Gold is really the anti-currency. It serves a valuable purpose in that it keeps all the other currencies honest (or exposes their dishonesty).

This may sound odd, but every currency has an interest rate tied to it. In essence, that interest rate is what the currency is all about. All those dollar bills in your wallet have an interest rate tied to them. The euro, the pound and the yen also all have interest rates tied to them.

Before I get to my model, I want to take a step back for a moment and discuss a strange paradox in economics known as Gibson’s Paradox. This is one the most puzzling topics in economics. Gibson’s Paradox is the observation that interest rates tend to follow the general price level and not the rate of inflation. That’s very strange because it seems obvious that as inflation rises, interest rates ought to keep up. And as inflation falls back, rates should move back as well. But historically, that wasn’t the case.

Instead, interest rates rose as prices rose, and rates only fell when there was deflation. This paradox has totally baffled economists for years. Yet it really does exist. John Maynard Keynes called it “one of the most completely established empirical facts in the whole field of quantitative economics.” Milton Friedman and Anna Schwartz said that “the Gibsonian Paradox remains an empirical phenomenon without a theoretical explanation.”

Even many of today’s prominent economists have tried to tackle Gibson’s Paradox. In 1977, Robert Shiller and Jeremy Siegel wrote a paper on the topic. In 1988 Robert Barsky and none other than Larry Summers took on the paradox in their paper “Gibson’s Paradox and the Gold Standard,” and it’s this paper that I want to focus on. (By the way, in this paper the authors thank future econobloggers Greg Mankiw and Brad DeLong.)

Summers and Barsky explain that the Gibson Paradox does indeed exist. They also say that it’s not connected with nominal interest rates but with real (meaning after-inflation) interest rates. The catch is that the paradox only works under a gold standard. Once the gold standard is gone, the Gibson Paradox fades away.

It’s my hypothesis that Summers and Barsky are on to something and that we can use their insight to build a model for the price of gold. The key is that gold is tied to real interest rates. I differ from them in that I use real short-term interest rates whereas they focused on long-term rates.

Here’s how it works. I’ve done some back-testing and found that the magic number is 2% (I’m dumbing this down for ease of explanation). Whenever the dollar’s real short-term interest rate is below 2%, gold rallies. Whenever the real short-term rate is above 2%, the price of gold falls. Gold holds steady at the equilibrium rate of 2%. It’s my contention that this was what the Gibson Paradox was all about since the price of gold was tied to the general price level.

Now here’s the kicker: there’s a lot of volatility in this relationship. According to my backtest, for every one percentage point real rates differ from 2%, gold moves by eight times that amount per year. So if the real rates are at 1%, gold will move up at an 8% annualized rate. If real rates are at 0%, then gold will move up at a 16% rate (that’s been about the story for the past decade). Conversely, if the real rate jumps to 3%, gold will drop at an 8% rate.

Here’s what the model looks like against gold over the past two decades:

The relationship isn’t perfect but it’s held up fairly well over the past 15 years or so. The same dynamic seems at work in the 15 years before that, but I think the ratios are different.

In effect, gold acts like a highly-leveraged short position in U.S. Treasury bills and the breakeven point is 2% (or more precisely, a short on short-term TIPs).

Let me make clear that this is just a model and that I’m not trying to explain 100% of gold’s movement. Gold is subject to a high degree of volatility and speculation. Geopolitical events, for example, can impact the price of gold. I would also imagine that at some point, gold could break a replacement price where it became so expensive that another commodity would replace its function in industry, and the price would suffer.

Instead of trying to explain all of gold, my aim is to pinpoint the underlying factors that are strongly correlated with gold. The number and ratio I used (2% break-even and 8-to-1 ratio) seem to have the strongest correlation for recent history. How did I arrive at them? Simple trial and error. The true numbers may be off and I’ll leave the fine-tuning to someone else.

In my view, there are a few key takeaways.

The first and perhaps the most significant is that gold isn’t tied to inflation. It’s tied to low real rates which are often the by-product of inflation. Right now we have rising gold and low inflation. This isn’t a contradiction. (John Hempton wrote about this recently.)

The second point is that when real rates are low, the price of gold can rise very, very rapidly.

The third point is that when real rates are high, gold can fall very, very quickly.

Fourth, there’s no reason for there to be a relationship between equity prices and gold (like the Dow-to-gold ratio).

Fifth, the TIPs yield curve indicates that low real rates may last for a few more years.

The final point is that the price of gold is essentially political. If a central banker has the will to raise real rates as Volcker did 30 years ago, the price of gold can be crushed.

Technical note: If you want to see how the heck I got these numbers, please see this spreadsheet.

Column A is the date.
Column B is an index of real returns for T-bills I got from the latest Ibbotson Yearbook. It goes through the end of last year.
Column C is a 2% trendline.
Column D is adjusting B by C.
Column E is inverting Column D since we’re shorting.
Column F computes the monthly change levered up 8-to-1.
Column G is the Model with a starting price of $275 (in red).
Column H is the price of gold. It goes up to last September.

Morning News: March 3, 2011
Posted by Eddy Elfenbein on March 3rd, 2011 at 7:32 am

Arab Turmoil Hits Markets

Oil-Tanker Contracts Gain 11% on Saudi Cargoes, Fuel Surge

IT’S DIFFERENT THIS TIME: Why Higher Oil Prices Won’t Kill The Economy

Harvard’s Rogoff Says Debt Restructuring `Inevitable’ in Greece, Ireland

World Food Prices Increase to a Record, United Nations Says

NYSE, Tokyo Stock Exchange Explore Trading Link

Bernanke Says Stronger Recovery Would Reduce State Woes

U.S. Treasury Expects $6.3 Billion From AIG’s MetLife Sale

World’s Largest Commodities Trader Glencore’s Annual Profit Up 40%

British Minister Backs News Corp. on BSkyB Deal

Twitter Has No Plans to Go Public

Oil Services Company Weatherford’s Shares Plunge As $500 Million Tax Accounting Errors Disclosed

Leigh Drogen: Is The US Dollar About To Crash?

Howard Lindzon: The StockTwits Blog Network Is In Effect!

26 out of 26
Posted by Eddy Elfenbein on March 2nd, 2011 at 2:08 pm

Gary Alexander alerts me to a fascinating stat:

March started with another market scare, but we’ve seen the same kinds of corrections in January and February with recoveries by month’s end. In January and February of this year, the S&P 500 rose a net 5.5%, including 2.3% gains in January and 3.2% gains in February. Since 1938, the S&P 500 has risen in both January and February 26 times. Since 1938, the full-year has been positive ALL 26 times in which the S&P rose in both January and February. The average annual gain in those 26 years was +20.73%.

Historically, March is a good month and April is #1, so we could see another couple of rising months in our near future. Over the last 50 years, according to Bespoke Investment Group, the Dow has gained an average 1.09% in March. Over the last 100 years, the average March is slightly better, +1.12%. April is historically the best month of the year, so we can anticipate another spring forward in stocks by April 30.

Morning News: March 2, 2011
Posted by Eddy Elfenbein on March 2nd, 2011 at 7:28 am

German Two-Year Yields Approach 18-Month High as Producer Prices Increase

Banco Pastor Issues Convertible Bonds as Spain Tightens Bank Capital Rules

Bernanke Signals No Rush to Tighten When Asset-Buying Ends

Debt Market Rebounds From the Crisis, and So Does Risk

Regional Fed Bank Names Economist as President

Futures Higher as Oil Rises Above $100 Per Barrel

Gold Holds Near Record as Mideast Simmers

Cotton Jumps by Daily Limit, Rises for Fourth Day as Supply Remains Tight

U.S. Car Sales Jumped in February, but Here Come Gas Prices Again

Yahoo in Talks on $8 Billion Japan Exit

Staples 4Q Net Up 17% On Fewer Charges; Sales Roughly Flat

Costco Quarterly Earnings Rise 16%

Joshua Brown: Guess Who No Likey the Oil Prices…

Howard Lindzon: Social Leverage, Social Proof and ‘Vertical is the New Horizontal’

Paul Kedrosky: TED Time: Mesopredator Release, Coyotes and Banks

ISM Ties for Best Reading in 27 Years
Posted by Eddy Elfenbein on March 1st, 2011 at 10:19 am

Today’s ISM Index report showed a reading of 61.4. That ties the reading from May 2004 for the highest level since December 1983.

This is the 19th-straight month that the ISM has been over 50.