Why markets see a Goldilocks year ahead

[FRED]

Why markets see a Goldilocks year ahead
October 2, 2006 (Anatole Kaletsky - Times Online)

The world economy is palpably slowing. American consumers, the main drivers of global growth for the past decade, are facing a retreat in their housing market that shows signs of turning into a rout.

In Germany and Japan, erstwhile economic powerhouses that seemed finally to be breaking out of a long torpor, business sentiment, industrial output and exports have turned down.

Seemingly insatiable demand from China and the rest of Asia, which a month ago seemed certain to drive oil and commodity prices still higher, has suddenly given way to anxiety about a global raw materials glut. Yet stock markets hit new five-year highs last week and the Dow Jones industrial average, the most famous, if not most representative, indicator of financial sentiment, is near a record.

Is there contradiction between rising optimism in stock markets and the gloom that appears to be spreading in the consumer and business worlds?

The answer is “Not at all”. A slowdown in global growth and industrial production, triggered by weakening in American housing and consumption, is just what the doctor ordered for the world economy. This sequence of events promises to create an almost ideal financial environment in the year or two ahead, particularly for the American, British and Asian economies. What seems to lie ahead is exactly the “Goldilocks economy” — with growth neither too hot nor too cold — that financiers around the world have been dreaming of. In short, the US Federal Reserve Board appears to have managed once again to fine-tune the growth of the US and world economies with uncanny precision.

AntiSpin: You gotta love these guys. The "US Federal Reserve Board appears to have managed once again to fine-tune the growth of the US and world economies with uncanny precision." That would be the same uncanny precision that brought us the 1990s stock market bubble and the early 2000s housing bubble. This will be one of those calls that we here at iTulip will be glad to revisit in a year or so to see if they got it right. Our guess is that with US inflation readings hitting an 11 year and the housing bubble collapsing more quickly than expected, the economic road ahead is more hard knocks than Goldilocks.

(Story Contributed by Chris Coles)

[DanielLCharts]

Re: Why markets see a Goldilocks year ahead

My lord, these guys (in this case Anatole Kaletsky) seem to jump to conclusions pretty fast, don't they? It ain't over 'til the fat rate cut sings.

[jk]

Re: Why markets see a Goldilocks year ahead

kaletsky is the "kal" in gavekal, which has had an upbeat take on the world economy for years. their book, "our brave new world," lays out their case that everything is more rosy than anyone on this board thinks. it's worth reading because they do point to some interesting phenomena. e.g. a "platform" company such as apple will contract out manufacturing to the cheapest source in asia. the manufacturer will show big production numbers which will pump up the gdp of the nation in which the manufacturer resides, but apple itself will have a far higher profit margin while retaining only the design, marketing and finance functions. my own thought here is that this might support the notion that corporate profits can be higher as a % of gdp than has been the case historically. anyway, it's no surprise for kaletsky to be saying everything is peachy. [of course it's also no surprise for me to be saying it isn't.]

[Jim Nickerson]

Re: Why markets see a Goldilocks year ahead

From John Hussman's weekly comments http://hussmanfunds.com/wmc/wmc061002.htm

October 2, 2006
Superstition and the Fed

John P. Hussman, Ph.D.

All rights reserved and actively enforced.
The stock market is currently more committed to “historically implausible themes” than at any time since the bubble peak in 2000. At that peak, stocks traded on a theme that assumed a “new era” of productivity, where recessions were avoidable by a skilled Federal Reserve, where technology earnings would grow at 30% annual rates indefinitely and where extreme valuation multiples were fully justified by that anticipated growth. All of those themes, of course, turned out to be incorrect, but one required a “durable sense of doom” to avoid getting sucked into the final advance. Even during that final advance, market internals began deteriorating notably, as measured by growing divergences across industry groups, poor breadth, waning volume, and other measures of weakening sponsorship.
Likewise, stocks are currently trading on a theme that assumes a “soft landing,” where profit margins will remain indefinitely wide, where price/earnings ratios – seemingly reasonable on the basis of “forward operating earnings” – will expand further, and where both inflation and recession can be avoided by a deft Federal Reserve.
Once again, we already observe both diminishing sponsorship and rich valuations on the basis of “normalized” earnings (i.e. assuming a gradual reversion to normal levels of profit margins and the share of income going to labor compensation). I've covered the valuation arguments regularly in these weekly comments. On the subject of unimpressive market internals, our own conclusions are confirmed by any careful examination of breadth.
For example, Lowry's notes “The rally in big-caps has been deceptively narrow. As of Thursday's close, with the DJ Average within just a few points of a new all-time high, none of the 30 components rose to new all-time highs. Further, 63.3% of the components showed losses of -20% or more from their individual all-time highs, and 43.3% showed losses of -40% or more. As of Thursday's close, 5.7% of domestic common stocks rose to new 52-week highs, while 26.7% already show losses of -20% or more. A concern for the future is that this degree of selectivity has typically been found near major market tops.”

jk made me aware of Hussman's funds and the information Hussman puts up each Sunday evening or early Monday. He (either Hussman or jk) strikes me as a smart man who is quite contrary to the Wall Street hype. I put some money in Hussman's HSGFX fund and watching it is every bit as exciting as watching paint dry.

[PeterM]

Re: Why markets see a Goldilocks year ahead

kaletsky is the "kal" in gavekal, which has had an upbeat take on the world economy for years. their book, "our brave new world," lays out their case that everything is more rosy than anyone on this board thinks. it's worth reading because they do point to some interesting phenomena. e.g. a "platform" company such as apple will contract out manufacturing to the cheapest source in asia. the manufacturer will show big production numbers which will pump up the gdp of the nation in which the manufacturer resides, but apple itself will have a far higher profit margin while retaining only the design, marketing and finance functions. my own thought here is that this might support the notion that corporate profits can be higher as a % of gdp than has been the case historically. anyway, it's no surprise for kaletsky to be saying everything is peachy. [of course it's also no surprise for me to be saying it isn't.]

Thanks for pointing out the name. I saw some pieces of Gavekal. I would not agree with all of them, but it gives another perspective.

Do you know what Gavekal sees as future economy? If I take that platform argument to the extreme, the next step is to outsource finance, marketing and design. Just keep the headquarters with some overhead in the US. The corperate profits might even further increase for that company, but what does it do to the earning/spending power of the former employees? Can you have an economy with only headquarters without any production?

see e.g. this chart

[Christoph von Gamm]

Re: Why markets see a Goldilocks year ahead

Can you have an economy with only headquarters without any production?

Well, this works out fine for a small economy of maybe highly skilled 8 - 20 million inhabitants who then govern the rest of a geography. Examples are Singapore, Switzerland and mabye to some extent New York City. Here, the upsides are as long as the neighbouring regions don't suffer too much, then they might offset labour intense processes to those places and arbitrage from labour cost. This only goes well until a certain trigger point is reached and the countries there either take over the headquarter - why not moving Apple into China, eh? or do not have a market enough to absorb the goods and services produced and governed by the headquarter companies.

On top of that, headquarter companies (those with only a few functions remaining) are usually quite good in the beginning with their cost reduction programme but at a certain point miss the turn around of markets and usually then have a big problem with a disfunctional and nonintegrated value chain. Examples here are GM where only a few subsidaries are profitable and doing well (Saab) or P&G who lose marketshare all over the place. Wonder why...

Besides, the workers released often bear some creative potential that then generates the offspring of new companies (Apple as an example with Steve Wozniak as an ex HPer)...

In other words, usually this "Goldilocks" thesis is nice for some years but then this generates the void and potential for new companies. Here it is important that in between the enterpreneurship of a region is fertile enough to breed those jumpstart innovators...

But putting a bet on big companies just living from global resources and doing nothing besides is risky.

[PeterM]

Re: Why markets see a Goldilocks year ahead

Well, this works out fine for a small economy of maybe highly skilled 8 - 20 million inhabitants who then govern the rest of a geography. Examples are Singapore, Switzerland and mabye to some extent New York City. Here, the upsides are as long as the neighbouring regions don't suffer too much, then they might offset labour intense processes to those places and arbitrage from labour cost. This only goes well until a certain trigger point is reached and the countries there either take over the headquarter - why not moving Apple into China, eh? or do not have a market enough to absorb the goods and services produced and governed by the headquarter companies.

On top of that, headquarter companies (those with only a few functions remaining) are usually quite good in the beginning with their cost reduction programme but at a certain point miss the turn around of markets and usually then have a big problem with a disfunctional and nonintegrated value chain. Examples here are GM where only a few subsidaries are profitable and doing well (Saab) or P&G who lose marketshare all over the place. Wonder why...

Besides, the workers released often bear some creative potential that then generates the offspring of new companies (Apple as an example with Steve Wozniak as an ex HPer)...

In other words, usually this "Goldilocks" thesis is nice for some years but then this generates the void and potential for new companies. Here it is important that in between the enterpreneurship of a region is fertile enough to breed those jumpstart innovators...

But putting a bet on big companies just living from global resources and doing nothing besides is risky.

Good examples. Exactly as my thoughts. The question were quire rhetorical. I just can see it work over the long run.
So the question that remains is ... how much time is there in this 'outsource-movement ' before the fall-out starts at a larger scale?

[jk]

Re: Why markets see a Goldilocks year ahead

whenever i see the "how can we survive with declining manufacturing jobs?" question, i remind myself that the same kind of question was raised when over 50% of the population was involved in agriculture but then started migrating to the cities. agriculture was obviously the basis of a healthy economy. after all, we all have to eat! but somehow we now have a very small population of farmers, at least in the u.s., where agriculture is quite productive. [i know a shift in energy costs, natural gas feedstock for fertilizer, etc, will make a difference, but i'm talking about today, not tomorrow here]. a large number of agricultural workers is just a sign of a poorly organized and inefficient ag sector. perhaps we are in the midst of a similar evolution.

[jk]

Re: Why markets see a Goldilocks year ahead

re the "platform" company model:

manufacturing, according to gavekal, is both capital intensive and cyclically vulnerable. thus by contracting it out a company improves its return on equity and insulates itself from economic swings. if nike sales go down, it's tough on the factory workers in indonesia but not so bad for folks at hq. and by not having so much capital exposed, profits aren't hit nearly as badly as would be the case if nike owned the factories.

the next step is that hq- design, marketing and treasury- gets dispersed and relocated to pleasant climes with low tax rates. "why pay taxes?" applies equally to highly compensated employees and to the platform company itself.

[DemonD]

Re: Why markets see a Goldilocks year ahead

whenever i see the "how can we survive with declining manufacturing jobs?" question, i remind myself that the same kind of question was raised when over 50% of the population was involved in agriculture but then started migrating to the cities. agriculture was obviously the basis of a healthy economy. after all, we all have to eat! but somehow we now have a very small population of farmers, at least in the u.s., where agriculture is quite productive. [i know a shift in energy costs, natural gas feedstock for fertilizer, etc, will make a difference, but i'm talking about today, not tomorrow here]. a large number of agricultural workers is just a sign of a poorly organized and inefficient ag sector. perhaps we are in the midst of a similar evolution.

This reminds me a bit of Isaac Asimov's vision of humanity's future. What if one day we have autonomous robots doing all our labor-intensive work? And then what would be to stop robots or artificial intelligence from doing white collar work?

I'm not offering a solution; it seems like a large part of the discussion here is a combination of historical and current macroeconomics combined with political science and philosophy, and these ideas are so grand in scale it's hard to comprehend, for anyone, how it will play out. I can understand how a housing market bubble bust and credit bust would create the need for macro liquidity and hyperinflation, which is why an investment in gold is grounded in some solid facts of the day. But sometimes the discussion of the generalities of the world economy and how we move forward is so big that two people can have completely opposite opinions and find enough facts and evidence to back up their view point.

Threads like this get me thinking about the nature and the meanings of words like "economy," "money," "currency." And that's where I sit here and scratch my head and think "hmmm, interesting." And then I don't know where to go with it, except the general knowledge of what I believe I should do with my investment portfolio.

the next step is that hq- design, marketing and treasury- gets dispersed and relocated to pleasant climes with low tax rates. "why pay taxes?" applies equally to highly compensated employees and to the platform company itself.

JK - now this is something I feel qualified to comment on. California (my home) has some of the highest taxes in the nation, both state income tax and sales tax. Some may argue, but the weather in southern california for my money's worth is the best in the world. 50-80 degrees all year round, hardly any rain, never any snow, mountains, beaches, babes. We have 8% and above sales tax, huge gasoline taxes, and, well, this speaks for itself right here:

from http://swz.salary.com/salarywizard/l...axrate_CA.html
(and re-checked from other sites, you can do your own DD by googling)

If your income range is between $0 and $6,146, your tax rate on every dollar of income earned is 1%.
If your income range is between $6,147 and $14,570, your tax rate on every dollar of income earned is 2%.
If your income range is between $14,571 and $22,996, your tax rate on every dollar of income earned is 4%.
If your income range is between $22,997 and $31,924, your tax rate on every dollar of income earned is 6%.
If your income range is between $31,925 and $40,345, your tax rate on every dollar of income earned is 8%.
If your income range is $40,346 and over, your tax rate on every dollar of income earned is 9.3%.

[jk]

Re: Why markets see a Goldilocks year ahead

JK - now this is something I feel qualified to comment on. California (my home) has some of the highest taxes in the nation, both state income tax and sales tax. Some may argue, but the weather in southern california for my money's worth is the best in the world. 50-80 degrees all year round, hardly any rain, never any snow, mountains, beaches, babes. We have 8% and above sales tax, huge gasoline taxes, and, well, this speaks for itself right here

you raise an interesting question. why would a company want to hq in california? it's more focused to ask why would a platform company want to hq in california? the weather-yes. the taxes-no. i don't know enough about the economy there. maybe someone here knows some examples of platform co.s that are in fact there, or have in fact moved out.

re the broader issues - e.g. is the world economy moving beyond manufacturing in a manner similar to that in which it moved beyond agriculture? although we can't really answer this question very well, i raise it in order to question the hysteria around the u.s. loss of manufacturing jobs. although it has no immediate investment implications, i think it bears on the issue of whether the u.s. has a sustainable economy once we give up the idea that we can support ourselves by selling each other houses. [this replaced the idea that we can support ourselves by day trading dot-com stocks.]

[hayfield]

Re: Why markets see a Goldilocks year ahead

whenever i see the "how can we survive with declining manufacturing jobs?" question, i remind myself that the same kind of question was raised when over 50% of the population was involved in agriculture but then started migrating to the cities. ... perhaps we are in the midst of a similar evolution.

A very valid point.

Was labor forced into the cities by the growing productivity of a smaller pool of farmers? Or was the industrial revolution driven by the ag component of the labor force voluntarily moving to cities for better opportunity in the industry? Historical evidence suggests that self-sufficient subsistence farmers left voluntarily for the promise of a better life with a factory job in a city. Events playing out in China suggest the same.

Is it the same case now, where manufacturing subsistence living is giving way to knowledge-based employment?

I ask myself "What did it take to make a factory worker from a subsistence farmer?" Then I ask "What does it take to make an 'intellectual property' employee from a factory worker?"

Considering that job training for displaced workers has a dismal track record, and more generally the educational system in this country is a wreck, I can not envision the necessary employment transition succeeding in the short term.

[PeterM]

Re: Why markets see a Goldilocks year ahead

I guess you can swing the history argument both ways, but in Holland the story was:
1. if a farmer did not mechanize he went out of business as labor energy was relatively too expensive when compared to petrol energy.
2. farm hands nearly starved in the country side and fled to the city to do anything that could bring in some money.
So it depends what you can 'voluntary' :rolleyes:


Warning - the following sounds harsh - I do not intend to insult any group. I just want to describe a general trend.

I think the transition from factory to knowledge worker if fundamentally different.
Farm and industrial work is mostly manual labor. Most people that can handle farm work can handle factory work, so I can see how that transition worked. No big group of non-useful people left behind.
However knowledge work does require a certain minimum intelligence level. Only part of the people has the IQ needed to absorb the education, stamina to go trough the training, funds to pay the education, etc. Unfortunately only a small part of the people will be able to function in this knowledge area. A larger group can only do 'factory work', but unfortunately that factory work was out-sourced over the past decades.
I see this as the left-behind group effect.


The next stage in happening now. Especially after the internet introduction, knowledge people have to compete internationally and they do not neccesarily have to be at at the place where their brain power is marketed. E.g. medical research in China and biotech research in Russia done for US corporations.

This trend of out-sourcing reduces the cost of corporations and increases the income of shareholders and management. I see this as a whealth transfer effect, where a smaller group will become wealthier. The broad group of employees that used to work at the factories and now also knowledge people associated with the company loose their job, hence less regional spending power.......... And then finally also HQ relocates to the Bahamas.

I fail to see how the original economy where the companies once stood can retain any resemblence with how it was. There is always an economy, but is it an economy you want to live in? What do the former employees do, how is value added and spending power generated? Flipping houses?
Of course the economy where the new factories and knowledge workers reside will get a lift.

If you look at it as an economist you may find it ok or desirable... after all it is just a reallocation of resources on a world scale. May be, if you would compare it with the farm-factory transition, you can opt to starve people left after outsourcing and see if they decide to migrate elsewhere .... China? Or wait until they drop their hourly wages up to the point they can compete in cost with the current undocumented workers in the US, forcing these people to leave. Or even lower wages up to China/India levels and hope some entrepeneur will invest in new production facilities in the US.
If you look at it as family or community member you may think otherwise. May-be, you too have familiy members not bright enough to compete with Indian/Chinese MSc's/PhD's. Indeed a philosofical question.

:eek: Eek, I have to stop here, am starting to sound like an anti-globalist.
Which I am not, I think. I don't have a quick solution. (Trade)barriers are probably even worse. But I think society has some tough choices ahead.

To get back to the economic side:
When I think about it, the out-source economies should get larger swings in their economic cycles as there is less resistence in closing plants, research etc. when the companies abroad deem this necessary. Does anybody know if that has been researched?

[jk]

Re: Why markets see a Goldilocks year ahead

To get back to the economic side:
When I think about it, the out-source economies should get larger swings in their economic cycles as there is less resistence in closing plants, research etc. when the companies abroad deem this necessary. Does anybody know if that has been researched?

if i understand you properly, this is precisely the point of gavekal's "our brave new world." "the out-source economies" such as china and indonesia are much more exposed to the volatility of the market place.

as for "knowledge workers," when i suggested we might be transitioning from a manufacturing economy to something else, i did not use the phrase "knowledge workers." as several posts have stated, knowledge workers are not numerous, and even they can often be replaced by cheaper knowledge workers abroad. what can't be replaced are service workers! hospital orderlies, retail clerks and, yes!, hamburger flippers! similarly doctors, store managers and sommeliers. [and carpenters and electricians and roofers - this is why housing was the perfect bubble- you can't import housing.]

we are transitioning to a service economy in which there are plenty of low-paying low-skill jobs available for the former farm laborers/factory workers. no benefits, of course. much less attractive than working the line at gm or u.s. steel in the old days. but even the hospital orderlies can afford a dvd player and, soon, a flat screen.

but, yes, as peterm points out, this will increase income and wealth inequality in the developed world.

[PeterM]

Re: Why markets see a Goldilocks year ahead

Just found that Mauldin recently wrote something about this
http://www.tigersharktrading.com/art...r-Recession%3F

In Our Brave New World, we wrote that one of the implications of the platform company model is that industrial jobs in the creative world disappear, only to reappear in Mexico, China, etc... Over time, the job market in developed economies moves to a minority of very creative individuals who work for themselves, and a majority of fellows who work in the service industry for the creative minds and/or the tourists coming in from the industrial world (this, of course, is a left wing politicians' worst nightmare, if for no other reason that their political parties all rely heavily on trade unions and organized labor for their funding, and to bring out the votes on election day).

And this is where it gets interesting: once the switch to the platform company model is made, companies usually realize that they should domicile their research and marketing activities in countries with low marginal tax rates.
Take the financial industry as an example: on any given day, the biggest foreign net buyer or seller of US Treasuries is the Caribbean Islands. Now needless to say, the Caribbean islanders are not amongst the world's largest investors; but the hedge funds domiciled there most definitely are. So the 'efficiency capital' of the world which used to be domiciled in big investment banks, in the world's financial centers (whether London, New York, Frankfurt, Tokyo...) has now re-domiciled itself in hedge funds whose legal structures are in the Caymans, Bermuda, the British Virgin Islands, etc... The tax revenue on the 'efficiency capital' is now lost for the US, the UK...; and there is little they can do to gain it back.

As an increasing number of companies move to the 'platform-company' model, or as people leave the big companies to work for themselves or smaller entities, it is likely that the top talent will want to work (or at least be taxed!), in low tax environments. This economic reality should lead to a structural decline in tax receipts in the countries which do not adjust to this new model. In the new world towards which we are rapidly moving, income taxes will becoming increasingly voluntary and governments will have to get their pound of flesh through property and consumption taxes instead. This is good news. Over time, it should lead to more efficient (i.e., downsized) governments all over the Western World. The platform company business model should end up killing off the Welfare State.

In the 'first wave' world, governments provided subjects a modicum of Regalian functions (police, army, judges). With the second wave, governments started to branch out and provided citizens with income redistribution, education, pensions, healthcare, unemployment insurance, etc...But in the 'third wave' world, will governments still be able to provide "prosumers" with all of the above services? How will they pay for them? In the 'third wave' world in which platform companies operate, taxes will increasingly become voluntary. Governments will thus have to compete with each other to provide the best services at the lowest possible costs to attract the world's best platform companies, and their workers. Over time, this should mean that governments which provide the most efficient Regalian functions, and at the lowest costs (Hong Kong? Singapore? ...) stand to survive in their current structures. Hong Kong is adapting to this economic reality. And that is great news for the local economy. We remain bullish on Hong Kong assets.

Fot the rest pls. use the link