Wednesday, April 19, 2017

Small luxuries to do well when wage growth stays stagnant

Consumers tend to buy the best of what they can afford, even if it’s within lower-priced categories. I developed a “small luxuries” investment theme, and my firm’s index of companies involved in premium beer and liquor, perfumes, luxury clothing, jewelry, home products and handbags outperformed the S&P 500 from the March 2009 market bottom, rising 616% vs. 251% for the total market.

Stocks that fit the bill include, Williams Sonoma, Tiffany & Co., Boston Beer Co., Coach and Ralph Lauren. Companies that can adapt to the demand for small luxuries will continue to be winners in the current environment where wage growth remains stagnant.

via forbes

Tuesday, April 11, 2017

Gary Shilling latest views on US housing and its effects on the economy

By many measures, the U.S. housing market seems in very good shape. The National Association of Realtors in Washington said last week that contracts to buy existing homes jumped 5.5 percent in February, the biggest increase since July 2010. Fannie Mae’s National Housing Survey showed that Americans expect home prices to rise a robust 3.2 percent over the next year as its sentiment index reached a record high.

So, are boom times ahead for housing? Not quite. To understand why, it helps to revisit recent history. The housing bubble of the early 2000s was driven by subprime mortgages and other loose-lending practices. The subsequent collapse left many potential new homeowners with inadequate credit scores, not enough money for a down payment and insufficient job security to buy a house. They also saw, for the first time since the 1930s, that not only house prices fall nationwide, but nosedive by a third. Homeownership plunged and those who did form households moved into rental apartments instead of single-family houses. 
That drove rental vacancy rates down and starts of multi-family housing -- about two-thirds of which are rentals -- up to 396,000 units, more than the earlier norm of 300,000 starts at annual rates. But single-family housing starts -- even with the rebound to an 872,000 annual rate from the bottom of about 400,000 -- are still far below the pre-housing bubble average of more than 1 million.

Despite the recovery in house prices, rents have risen at a much faster pace. As a share of median income, rents have jumped while mortgage costs have fallen. The latest data from the National Association of Realtors show its Housing Affordability Index was up 52 percent in the fourth quarter of 2016 from the early 2007 low.

Even with conditions shifting away from rental apartments in favor of single-family housing, the homeownership rate is unlikely to rise from the current 63.7 percent to anything like its fourth quarter 2004 peak of 69.2 percent because of the reasons listed earlier. Many believe that because of the rise in Americans in the first-time homebuying age range of 25 to 44, there is a huge batch of households just waiting to buy single-family houses or at least rent more apartments.

Demographics are important in the long run, but that can be the very long run. There is little correlation between the number of U.S. households and the population aged 25 to 44. The speculative boom in housing in the early 2000's and the subsequent collapse were far more important to the broad universe of households than the number of people in the prime ages for buying or renting.

The one-third plunge in home values shocked house flippers by proving that prices can and do fall significantly. Many believed that prices not only always rise, but climb faster than overall inflation. But real house prices were essentially flat for more than a century. They leaped almost 100 percent during the bubble before falling, and are not yet back to the long-run average. I look for a reversion to the mean that could last just as long.

The current homeownership rate is essentially at its long-term average before the bubble. So it’s not at a depressed level just waiting to leap. In fact, the rate, which averaged 66.7 percent during the boom and bust, may be subdued for years if the previous long-run average of 64.3 percent is still valid. And it might well be, now that the bloom is off the ownership rose.

Just as house prices and homeownership leaped in the bubble and then collapsed, so did the effect on GDP of housing’s rise and fall. The cumulative contribution to real GDP from the second quarter of 2000 to the fourth quarter of 2005, including residential construction spending and consumer spending on home maintenance, etc., was $183 billion. But the subsequent drop to the bottom in the first quarter of 2012 subtracted $393 billion. So the round trip boom-to-bust result was a negative $210 billion.

That net loss was 1.5 percent of average GDP during the cycle, but the total impact was much worse because of the distorting effects of the huge rise and then even bigger drop in housing. On the way up, many who were not financially equipped to own houses got sucked in by mortgages that required no documentation of income and assets -- “no doc loans” -- or they took out “liar loans” by submitting numbers that had no verification. Many believed the pitch from mortgage lenders that they’d never have to make a monthly payment on a zero-down loan because the appreciation of their houses would permit refinancing, even with cash-out before the first installment was due.

Not only did most of those folks suffer as their mortgages were foreclosed, but many who didn’t had negative equity in their houses as values dropped below what was owed on the mortgages. So they could not refinance as mortgage rates fell. Then there are all the unsuspecting investors who bought pieces of securities backed by subprime mortgages that were rated AA or A by ratings firms but in reality were worthy of D, or default, ratings. And default many of them did.

Housing has recovered from the depths, and a shift from rental apartment buildings to single-family construction is under way. But don’t look for anything like the boom of the early 2000's, and the stimulating effects it had on the overall economy.

via bloombergview

Monday, April 3, 2017

Why the Asian century may not arrive in our life time

People in the West, certainly Americans, have long had a fascination with the East, with many predicting an inevitable “Asian century” marked by economic and market dominance. I have long disagreed with the consensus on China and other Asian Tigers, and others are beginning to agree. Many problems stand in the way of the “Asian century.”

Japan dazzled Westerners with the speed of its recovery from the ashes of World War II. Japanese purchases of U.S. trophy properties such as the Pebble Beach golf resort in California and Rockefeller Center in Manhattan in the 1980's, on top of the leaping property and equity prices in Japan, convinced many in the West that Japan would soon take over the world.

Japan’s economic decline in the early 1990's did not curb fascination with Asia. It simply shifted to the rapidly-growing developing economies, the Asian Tigers. The original four, Hong Kong, Singapore, South Korea and Taiwan, were later augmented by the likes of Malaysia, Thailand, the Philippines and, of course, China -- and more recently, Pakistan, Vietnam, Indonesia and Bangladesh.

The late-1990s Asian financial crisis only temporarily disrupted Western fascination with the East and the prospects for an “Asian century.”

The 2007-2009 Great Recession and financial crisis ended rapid economic growth in Western countries and, therefore, the robust demand for exports that were the mainstay of developing economies. Still, Western zeal for Asia persisted and many, for no logical reasons, believed emerging countries could independently continue to grow rapidly and, indeed, support economic activity in the sluggish U.S. and Europe.

Chinese real economic annual growth rates nosedived from double digits to a recessionary 6.3 percent during the worldwide downturn, but then revived due to the massive 2009 stimulus program. Easy credit fueled a property boom and inflation, and excessive infrastructure spending replaced exports as the growth engine. As with the Asian Tigers earlier, many thought Chinese growth was self-sustaining and unrelated to ongoing sluggish economic performance in North America and Europe, especially after Chinese GDP topped Japan’s in 2009.

There are five main reasons why it won’t get any easier for Asia:

1. Globalization is largely completed. There isn’t much manufacturing in North America and Europe left to be moved to lower-cost developing economies. At the same time, the West is basically saturated with Asian exports, and those countries are competing fiercely among themselves for limited total export demand. Also, exports are shifting among those countries as low-end production moves from China to places such as Pakistan and Bangladesh, much as they shifted out of Japan in earlier decades. As economies grow, a greater share of spending is on services and less on goods. This reality is a long-term drag on almost all the other Asian lands, except India, due to their goods-export orientation. This will temper long-term growth for Asian goods exports even after rapid economic growth resumes in the U.S. and possibly other Western economies.

2. The shift from being export-led economies to ones driven by domestic spending, especially by consumers, has been slow. Chinese leaders want this transition, but it is moving at glacial speed. At 37 percent, Chinese consumer spending as a share of GDP is well below major developed countries such as the U.S. at 68.1 percent, Japan at 58.6 percent, and even Russia at 51.9 percent.

3. There are government and cultural restraints. Almost all developing Asian economies are tightly controlled by governments. Top-down regimes stoutly resist reform and often persist until they’re overthrown by revolutions. The current Mao dynasty in China, as I’ve dubbed it, seems seriously worried about popular unrest due to the lack of promised economic growth and is reducing what little political liberty was previously allowed. President Xi is now the Big Brother with lots of little brothers insuring proper thoughts and actions, even at the local level.

In Malaysia, Prime Minister Najib Razak is enmeshed in a multibillion-dollar investment scandal. In the Philippines, crime and drug trafficking are so rampant that President Rodrigo Duterte was elected on a platform of eliminating drug dealers, even by murderous vigilante squads. South Korea’s former president Park Geun-hye was thrown out over corruption.

4. Population problems endure. Despite the need for new workers in Japan as its population falls and ages, women are still discouraged from entering the labor force, and Japan continues to be unwelcoming toward newcomers. There’s no such thing as an immigration visa despite the fact that 83 percent of Japanese hiring managers have difficulty filling jobs, versus a global average of 38 percent in the last five years.

China also has a looming labor shortage and severe limits to economic growth due to its earlier one-child policy, which resulted in about 400 million Chinese not being born. Low fertility rates are also destined to reduce the populations of Hong Kong, Taiwan, Singapore and South Korea. At the other end of the population spectrum are Asian countries like Indonesia and India, whose population is expected to exceed China’s by 2022.

5. Military threats are growing in Asia, and could severely disrupt stability and retard economic growth if they flare up. China is exercising its military muscles by challenging U.S. military influence in the region by, among other actions, building military islands on reefs in the South China Sea. Japan is abandoning its post-World War pacifism and shifting from defensive to offensive capabilities. The Russians are also making military threats. The region contains five nuclear-armed countries: China, India and its rival Pakistan, Russia, and -- most troubling -- North Korea, which is testing long-range missiles. China isn’t happy about that, but it wants North Korea as a buffer between it and South Korea as well as a deterrent to its old foe, Japan. 

There may well be an “Asian century” in the future, but don’t hold your breath. It took about a millennium for the West to develop meaningful democracy, the rule of law, large middle classes that support domestic economies and all the institutions that are largely lacking in developing Asian lands.

via BloombergView

Wednesday, March 15, 2017

Trump could start a massive fiscal stimulus program

Most forecasters believe the Trump administration’s forecasts of 3 percent to 3.5 percent annual real gross domestic product growth in the next decade are far too rosy. The nonpartisan Congressional Budget Office foresees 1.9 percent per year between 2021 and 2027, and the Federal Reserve expects 1.8 percent annually in the long run.

These differences aren’t trivial. Growth at 3.5 percent per year rather than 1.8 percent would make the economy 18 percent bigger over a decade. It also would involve reducing federal budget deficits by cutting spending on programs such as food stamps and unemployment insurance while boosting taxable personal and corporate incomes.

Pessimists point to the ironclad law of economic growth: Annual increases in employment plus productivity growth equal yearly gains in economic output. Aging and retiring postwar babies, as well as President Donald Trump’s anti-immigration policies, will severely limit labor force growth, they maintain. And output per hour worked, which gained about 2.5 percent a year in earlier decades, has risen just 0.5 percent annually in the 2010-2016 years.

Some blame weak capital spending while others foresee no big productivity-soaked new technologies coming along to propel productivity because everything worth inventing is extant. Malthus is alive and well. At the opposite end of the spectrum are those who believe robots will replace people to the point that there will be too few earners to buy the nation’s output.

I disagree. First of all, consider the bias of most forecasters toward slow growth forever. Since this business expansion started in mid-2009, real GDP growth has averaged a mere 2.1 percent despite the Federal Reserve’s cuts in short-term interest rates to zero and huge quantitative easing. So the tendency of most is to assume that this pattern will last indefinitely and they select evidence to substantiate that view. It’s the easiest forecast to sell as forecasters’ audiences readily agree because it matches their ongoing experience.

Still, the ironclad law of economic growth is actually quite pliable. Real GDP annual growth of 3.5 percent would occur with 2.5 percent yearly growth in productivity and 1 percent rises in employment, the historic numbers. True, with low fertility rates, the Census Bureau sees the U.S. population rising just 0.2 percent a year by 2026, even with net immigration of 1.3 million annually over the next decade.

Nevertheless, the labor participation rate -- the percentage of the population over 16 that is employed or actively looking for work -- had plummeted to 62.9 percent in January from the 67.3 percent peak 17 years earlier. So 4.4 percent of the potential workforce, or 11.3 million people, have departed. About 60 percent were retiring postwar babies, but many are returning or staying in jobs past normal retirement ages because their health is better than their predecessors’ and because they need the income. Postwar babies have been notoriously poor savers throughout their lives. The participation rates of those over 65 are actually rising, not falling, as is normally true for seniors.

Also increasingly looking for work are youths who stayed in school during the dark Great Recession years and are now better educated and attracted by expanding job openings. In addition, skills to meet available jobs are being provided by apprenticeship programs that combine two-year college degrees with on-the-job training. German manufacturers brought this system with them to their factories in the U.S. Southwest, and it is increasingly being emulated by U.S. firms.

Trump’s threats of mass deportation of undocumented immigrants have been scaled back. They now target those with criminal records and other suspects. And with cooler heads in Congress, U.S. immigration policy may end up mirroring Canada’s with a point system aimed at admitting those with the skills this country needs.

Trump’s planned deregulation and lower corporate tax rates may spur capital spending, but the correlation between the growth in capital expenditures and productivity gains is low, sometimes negative. More machines alone don’t spur efficiency. More important, productivity-enhancing new technologies grow explosively, but since they start from essentially zero, it takes decades before they move the productivity needle significantly. Aside from those yet to be developed, today’s well-known technologies such as robotics, additive manufacturing, biotech and self-driving vehicles are no doubt still in their infancy.

The argument that protectionism inhibits economic growth is also suspect. Sure, eras of rapid global economic growth are also periods of strong foreign trade advances, but do trade gains stimulate economic activity or the reverse? You can’t prove causality with statistics. If you beat a drum every time there is a total eclipse of the sun, it will go away. No causality, but 100 percent correlation.

Also questionable is the robots-will-eliminate-workers theory. A recent McKinsey study found only 5 percent of 800 occupations and 2,000 job tasks are likely to be entirely automated. Instead, half of current jobs will be changed significantly, forcing employees to adjust. At the same time, automation may hike global productivity by 0.8 percent to 1.4 percent per year during the next half century.

The catalyst for the return to rapid economic growth will, no doubt, be a huge fiscal stimulus program. Voters who are mad as hell after a decade or more of no growth in real incomes elected Trump and the Republican Congress, and politicians will respond. It will take two or three years to come to fruition, but look for huge infrastructure outlays and large increases in military spending. 

Stocks don’t normally discount that far ahead, but maybe that’s what leaping equities are anticipating, despite all the uncertainty in Washington, the nation and, indeed, the world.