This is one of my favorite GDP graphs. The graph below shows the contribution to GDP from residential investment, equipment and software, and nonresidential structures (3 quarter trailing average). This is important to follow because residential investment tends to lead the economy, equipment and software is generally coincident, and nonresidential structure investment trails the economy.
In the graph, red is residential, green is equipment and software, and blue is investment in non-residential structures. So the usual pattern - both into and out of recessions is - red, green, blue.
The dashed gray line is the contribution from the change in private inventories.
Note: This can't be used blindly. Residential investment is so low as a percent of the economy that the small decline earlier this year was not a concern.
Click on graph for larger image.
Residential investment (RI) increased at a 1.8% annual rate in Q3 - and RI only contributed 0.06 percentage points to GDP growth. For the rate of economic growth to increase, RI will probably have to make larger positive contributions to economic growth.
Equipment investment increased at a 7.2% annual rate, and investment in non-residential structures increased at a 3.9% annual rate. Equipment and software added 0.41 percentage points to growth in Q3 and the three quarter average moved down slightly (green).
The contribution from nonresidential investment in structures was also positive in Q3. Nonresidential investment in structures typically lags the recovery, however investment in energy and power provided a boost early in this recovery.
I expect to see all areas of private investment increase over the next few quarters - and that is key for stronger GDP growth.
Here's the question of the day: Could Non-Citizens Determine the Outcome of the Midterm Elections?
Some elections, especially for Senate are so close, the unfortunate answer is "yes" as the following video insight from Insight from the Libre Institute explains.
Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.
Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.
After a rough start to October, the S&P 500 finished the month at a new all-time closing high. So which way will the market go from here? Please take part in our weekly Bespoke Market Poll below by letting us know whether you think the S&P 500 will be higher or lower one month from now. We'll report back with the results on Monday before the open. Thanks for participating, and have a great weekend! Happy Halloween!
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1. Q3 GDP rose 3.5% vs expectations of 3.1%.
2. The Fed officially ended QE, the market stood on its own two feet.
3. Consumer confidence came in at 94.5, the highest levels since October 2007.
4. Chicago PMI came rose to a 12-month high of 66.2.
5. Richmond Fed manufacturing index came in at 20 v expectations of 11.
6. University of Michigan consumer confidence rose to 86.9, the best reading since 2007.
7. Japan industrial production rose 2.7% m/o/m, better than the 2.2% expected.
8. The S&P 500 finished October 2% higher after being down as much as 7.7% earlier in the month.
9. The BOJ said it will triple the size of its easing measures. The Yen fell to a 7-year low and the Nikkei gained 4.8%.
1. U.S. core durable goods dropped 1.7%, their largest decline since January. Expectations were for a 0.6% rise.
2. Home prices fell 0.15% m/o/m in August, versus expectations of an 0.18% rise. Y/O/Y came in at 5.6%, just below expectations.
3. German inflation fell to 0.7% y/o/y and was down 0.3% m/o/m.
4. Initial jobless claims rose slightly to 287k.
5. Japan’s unemployment rose to 3.6%, the highest since 1997.
But it is too long! 3000 words! Help! What can I do?
Oeconomicarus: But I thought you read 300 books a year?
Princeps Cogitationis: I read the last chapter of 300 books a year. Then I read three short reviews of each. And then I opine fearlessly. Working through a difficult 3000-word argument and assessing it is not a good use of my time. READ MOAR
Oeconomicarus: So you want me to use my time enlightening you so that you can stamp your brand on my thoughts and make money off of them?
Princeps Cogitationis: Exactly!
Oeconomicarus: Were you not a literary figure of my rhetorical imagination, and did my Demiurge not have the opportunity to attempt to use twenty first-century communications technologies to leverage this dialogue across an audience global in scope, I would tell you to go where you deserve.
Princeps Cogitationis: But you won't, will you?
Princeps Cogitationis: Well?
Knut Wicksell: You need to start by recognizing that financial markets powerfully influenced by central banks set the economy's (safe) real interest rate; that when this market (safe) real interest rate is below the economy's current "natural" interest rate we have (unexpected) inflation; that when this market (safe) real interest rate is above the economy's current "natural" interest rate we have depression; and that when this market (safe) real interest rate is at the economy's current "natural" interest rate we have prosperity (and stable inflation)...
Speculatoricus: And you need to start by recognizing that one factor that can raise the economy's current (safe) "natural" interest rate is wild and enthusiastic financial overspeculation--but that such "bubbles" can do so only temporarily and unsustainably...
Accumulator: And you need to start by recognizing that no matter what it does the central bank cannot push the market (safe) real interest rate below -π, where π is the current rate of inflation. Because savers can always hoard goods or cash, the market nominal interest rate cannot fall below zero, which means the market (safe) real interest rate cannot be less than the arithmetic inverse of the rate of inflation.
Princeps Cogitationis: The four of you have lost me.
Oeconomicarus: (To Speculator, Accumulator, and Knut Wicksell) SHUT UP!! (to Princeps Cogitationis): The central bank controls the market interest rate, and needs to set it no higher than the economy's natural interest rate to avoid depression. But when inflation is low, the natural interest rate may be so negative that even when the central bank pushes the market interest rate to zero it still doesn't do the job! OK?!?!
Princeps Cogitationis: OK...
Princeps Cogitationis: But what is this about bubbles and inflation?
Oeconomicarus: If the natural interest rate in terms of money is stuck at less than zero, a higher rate of inflation can raise it and bubble psychology can raise it--both make people less eager to hold cash and more eager to put their money to work, and so both raise the natural interest rate in terms of money, and then the central bank can do its job of avoiding depression.
Princeps Cogitationis: But?
Oeconomicarus: Bubbles are, by their nature, unsustainable--hence not a permanent solution--and disruptive. They are not a good answer to a situation in which the economy's natural rate of interest is less than zero. Price stability--an inflation rate of 2%/year or less--is also a good thing to have: it makes business and other economic decisions more rational. Hence if at low inflation the non-bubble natural rate of interest in money terms gets stuck less than zero, we have a big macroeconomic problem. Larry Summers says that it is, and we do.
Princeps Cogitationis: So what is the way out?
Oeconomicarus: One way is a higher inflation target than our current 2%/year--or actually 1.75%/year--but Larry doesn't like that for some reason. The second way is:
increased public investment, reduction in structural barriers to private investment... promot[ing] business confidence...
The third way is:
basic social protections so as to maintain spending power... reduc[ing] inequality... redistribut[ing] income towards those with a higher propensity to spend...
Clio: Seems to me that I have heard of these three before...
Oeconomicarus: Yes. The third is basically J.A. Hobson's Imperialism--that an unequal income distribution either required governments to dissipate huge amounts of wealth in conquest and colonization or suffer chronic depression. The second is, in a way, Hayek: that when the long-run rate of profit is not high enough to support the roundabout investments made, overaccumulation is inevitable, and it will then lead to necessary depressions. And the first is basically Friedman's monetarist k%/year money-stock growth rule as a "neutral" monetary policy, with the in petto corollary that the money-stock growth rate has to be high enough to give enough of an incentive to spend liquid assets for monetarism to gain traction...
Princeps Cogitationis: So why is the problem showing up now?
Slower population and possibly technological growth means a reduction in the demand for new capital.... Lower-priced capital goods means... given... saving... purchase[s] more capital.... Iconic cutting edge companies have traditionally needed to go the market to support expansion. Today leading edge companies like Apple and Google are attacked for holding on to huge cash hoards. Rising inequality... raise[s]... income going to those with a lower propensity to spend.... Greater risk aversion... and increased regulatory burdens... debt overhangs... increased uncertainty discourages borrowing... raise the wedge between safe liquid rates and rates charged to borrowers...
Jean-Baptiste Say: But the market can fix it, right? I mean, as long as there are any ways to durably store purchasing power, all you have to do is push the real interest rate below zero for long enough and demand for investment in such storage will rise to get us to full employment, right?
Oeconomicarus: Not if a lack of trust in financial markets creates a failure to mobilize the economy's risk-bearing capacity...
Thrasymachus: How much would you trust Citigroup or JPMC right now if it told you it had a gold-plated risk-free profitable long-run investment vehicle that you could buy?
Princeps Cogitationis: So if we don't fix this, what happens to us?
Oeconomicarus: Perhaps a 15% reduction in our prosperity relative to what we might have attained, followed by permanently slower growth thereafter:
Potential output has declined almost everywhere and in near lockstep with declines in actual output.... When enough investment is discouraged in physical capital, work effort and new product innovation... 'Lack of Demand creates Lack of Supply'... potential declines, the [natural rate of interest] rises, restoring equilibrium, albeit not a very good one...
Princeps Cogitationis: Suppose I sign up for Summers's "Third Way" policy of radical income redistribution on the first hand, restoration of business confidence and increases in the rate of profit via the government providing various puts to risk-takers and entrepreneurs on the second hand, and aggressive expansionary infrastructure-oriented fiscal policy on the third hand--and it doesn't work. What is wrong with a higher inflation target?
Apollo: I must say, it does seem rather Delphic: Summers says:
Even if the zero interest rate constraint does not literally bind, there is the possibility that the positive interest rate consistent with full employment is not consistent with financial stability. Low nominal and real interest rates... increase risk taking as investors reach for yield, promote irresponsible lending as coupon obligations become very low and easy to meet, and make Ponzi financial structures more attractive as interest rates look low relative to expected growth rates.... Operating with a higher inflation rate target... or... finding ways such as quantitative easing that operate to reduce credit or term premiums... are also likely to increase financial stability risks...
Oeconomicarus: Perhaps it is best to say that effective price stability--the expectation of stable 2%/year inflation--is a very costly, hard-won, and valuable property of a market economy. It greatly reduces inflation-tax distortions and allows for more accurate economic calculation. It should not lightly be thrown away. And there is no reason to throw it away: progressive income redistribution, the proper mobilization of the economy's entrepreneurial risk-bearing capacity, and a proper infrastructure-investment oriented fiscal policy can in all likelihood do the full job by themselves.
Princeps Cogitationis: You have just made me sit through a twenty-minute dialogue! I could have read Summers's original piece in ten minutes!
Thrasymachus: But you wouldn't have read it, would you? And if you had you wouldn't have understood it, because you would still be ignorant of the proper intellectual context, wouldn't you?
Princeps Cogitationis: But how do I boil this down to soundbites? I need soundbites--preferably scary ones about risks that make people sit up and pay attention!
Oeconomicarus: Sorry. Can't help you. The secular stagnation income has very high asset prices and healthy profits because the lousy labor market produces a depressed labor share. It's not very good for entrepreneurs. But it's not the kind of thing to scare the currently rich--that is one big reason we are right now in it.
Thrasymachus: If you want soundbites, go over there to practice "We just jumped the gun on our forecast of hyperinflation! Obamacare is collapsing under its own weight! Massive debasement from quantitative easing is still great threat! Lowering interest rates is a cause of deflation! The spike in the VIX this October proves it" with John Cochrane, Niall Ferguson, Douglas Holtz-Eakin and company...
Princeps Cogitationis: Douglas Holtz Eakin?
Thrasymachus: Yep: Holtz-Eakin says he is going to declare victory, someday:
...In my assessment, the medium-term outlook for inflation has shown no overall improvement since last December and, indeed, is arguably worse. Failing to act in response to this subdued inflation outlook increases the downside risk to the credibility of our 2 percent inflation target. Market-based measures of longer-term inflation expectations have fallen recently to unusually low levels, a decline that I believe reflects that kind of increased downside risk...
Today's reading on inflation is supportive of Kocherlakota's concerns:
He reiterated his preferred policy outcomes:
There are a number of possible actions that I would have seen as responsive to the evolution of the data. Let me describe two in particular. First, the Committee could have continued to buy $15 billion of longer-term assets per month. Second, it could have committed to keeping the target range for the federal funds rate at its current level at least until the one- to two-year-ahead inflation outlook has risen back to 2 percent, as long as risks to financial stability remain well-contained.
For example, the Committee could have adopted language of the following form: “the Committee anticipates keeping the fed funds rate in its current range at least until the unemployment rate has fallen below 5.5 percent, as long as the one-to-two-year-ahead outlook for PCE inflation remains below 2 1/4 percent, longer-term inflation expectations remain well-anchored, and possible risks to financial stability remain well-contained.”
Notice that earlier this year the best he thought he could get from his colleagues was an allowance for 2.25% inflation. Now the best he could hope for has been downgraded to a 2%, suggesting - you guessed it - that the rest of the FOMC considers 2% a ceiling.
I think the inflation downgrade in Kocherlakota's suggested policy language suggests that low inflation is less of a concern for FOMC members now that unemployment is below 6% and measures of underemployment are improving. I believe that Kocherlakota is hearing from his colleagues that 1.) inflation will almost certainly move toward target as the unemployment rate falls further and that 2.) even if inflation remains below 2%, declining slack in the labor market suggests that less financial accommodation is necessary and failure to reduce accommodation will result in undesirable financial instability.
Bottom Line: Kocherlakota's dissent raises the possibility that labor data will trump inflation data in policy considerations. It also suggests that given the pace of labor market improvement, they are not writing off the possibility of a March rate hike (although that is not my baseline).
As highlighted in our prior post, the average stock that has reported this earnings season has averaged a big gain of 0.99% on its report day. Below is a look at the average one-day performance on earnings this season broken up by sector. As shown, the average Health Care stock that has reported has gained a whopping 2.14% on its report day this season. No wonder the sector has gone parabolic recently! Telecom, Consumer Discretionary and Technology are the three other sectors that are seeing out-sized gains on their report days.
On the downside, Energy sticks out like a sore thumb. As if the sector didn't have enough trouble coming into earnings season, investors have continued to unload Energy shares even after they report. As shown below, Energy is the one sector where stocks are averaging declines on their report days. When will the bottom be put in?
Nearly 1,500 US companies have reported earnings since the third quarter season began in early October. As shown below, the average stock that has reported this season has gained 0.99% on the day of its report. (For companies that report in the morning, we use that day's change. For companies that report after the close, we use the next day's change.)
If the season were to end today, the current average one-day gain of 0.99% would be the best reading for earnings since the first quarter of the current bull market. Investors are clearly willing to step in and buy stocks on earnings this season. Something that we hadn't seen during the prior two quarters, when the average stock fell pretty significantly in reaction to its report.
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Boy oh boy – I live for this stuff! Massive moves across the board and of course Thor is loving it. Before you guys head out and slip into your Halloween costumes I wanted to serve up a few more charts as we are seeing had significant developments across the board:
The E-Mini (and the S&P cash) just painted a new all time high – who would have expected that just two weeks ago? Well, we didn’t but we had the foresight to go long near 1860 and our accounts have been blinking green ever since. As I said – this thing is just getting warmed up. Today it’s going to be pretty much ramp & camp here and most likely we’ll be seeing a shake out next week. But the weekly is donning a brand spanking new buy signal and unless disaster strikes before the close it’s on the books.
GOLD!! Actually was looking at being long yesterday but to my credit I pointed out that being short below 1170 is recommendable. And we just breached that and a brand spanking new weekly NLSL. Wow this is huge! Just look at the monthly panel to grasp the significance of what’s happening here. The gold bugs are near a panic no doubt and this could easily fall off the plate. I expect some gyrations here at this major inflection points but being short with a stop above the 1237 NLBL is the name of the game now.
Two more juicy long term charts waiting below – please meet me in the lair:
More charts and commentary below for anyone donning a secret decoder ring. If you are interested in becoming a Gold member then don't waste time and sign up here. And if you are a Zero subscriber you get free access to all Gold posts, which gives you double the bang for your buck!