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ABS, CMBS prices continue to rise



The top chart shows the price of an index of home equity-backed securities, while the bottom chart shows the price of an index of commercial mortgage-backed securities. Both show strong price gains, and I would note that prices have been rising since last summer. It's particularly interesting to see these price gains come at a time when the whole world is anticipating a new wave of home foreclosures and widespread distress in the commercial real estate market. These charts are saying the reality is not likely to be nearly as bad as the hype.

This also provides more confirmation that the real estate market has bottomed and may even be improving. A year ago the prices of asset-backed securities such as these were priced to Armageddon—to the expectation of truly massive defaults nationwide. Now they are priced to merely difficult conditions, but that represents a huge improvement.

These charts also suggest that asset backed securities such as the ones represented in these indices, which were marked down severely last year by many institutions because they were considered "impaired," will at some point be marked up, resulting in very welcome additions to corporate profits.

Gas is $9 a gallon in the U.K.

This is a milestone of sorts, until a new record-setting price inevitably appears as a result of the accommodative monetary policies of the worlds' central banks and the global mania for curbing carbon emissions. Gasoline has now hit $9 a gallon in parts of the U.K. Can U.S. consumers even imagine a price that high? It wouldn't be too hard to achieve, given the weakness in the dollar, the Fed's super-accommodative monetary policy, the renewed push for a cap and trade regime or a carbon tax to reduce hydrocarbon fuel usage, and the rising ethanol requirements (ethanol being a less efficient fuel).

Obama's negatives continue to outweigh his positives



In my view, this data from Rasmussen paints a picture of a deeply unpopular president. More than half of the people consistently have disapproved of his job performance for most of the past 4-5 months. The bounce in his "approval index" that occurred in the wake of the passage of the healthcare reform bill was most likely due to moderates in his party cheering his apparent Congressional success. But his negatives have remained consistently high for many months and have not wavered. If I'm right, we should see his "approval index" soon return to its previous lows, as independents and liberals despair over his leftward overreach on ever-more issues. His efforts to appease Russia with today's nuclear arms reduction treaty, and his utter disregard for Israel and the U.K., traditionally among our staunchest allies, are not going to play well with the majority of the people. At the rate things are going, I would expect to see this index plumb new lows before too long.

I will be very surprised if the November elections do not result in huge losses for the Democrats. More importantly, I think the elections will mark a key "tipping point" in U.S. politics, in which the political spectrum begins to be divided not on social issues (abortion, gay rights, etc.), but on the proper role and size of the government. Obama and the liberals have made it clear they want more government, but I am convinced that the great majority of the people want less government.

I plan to attend my local Tea Party rally next week (April 15), and I encourage every freedom-loving and big-government-hating citizen to do the same.

U.S. to South African poor: "stay poor, we can't afford more carbon emissions"

I would be among the last to endorse giving money to the World Bank so it can in turn finance projects that help the world's underdeveloped countries. That's because I think they are typically wasteful, inefficient, and likely candidates for massive corruption, and could be much better undertaken by private capital. But I was amazed to learn, thanks to good friend Don Luskin, that the U.S. government has declined to endorse the Eskom Power Investment Support Project, whose aim is to finance $3.75 billion worth of energy generation projects in South Africa.

Why? Here is an excerpt from today's press release from Treasury:

South Africa and the region face urgent energy needs to promote economic growth and address critical challenges, such as poverty, education and health.  This project would provide significant energy capacity to meet these essential needs.  We recognize that South Africa faces limited options that could provide the required energy base for South Africa and the region in lieu of the project, and that there is a lack of alternative private financing options in the wake of the financial crisis.  We also recognize that, if South Africa's base load power needs are not met, the country's economic recovery will suffer, adversely impacting electrification, job creation, and social indicators.

Despite these benefits, the United States is concerned about the project since it would produce significant greenhouse gas emissions, and uncertainty remains about future mitigation efforts.
In other words, the U.S. can't countenance a project that would help lift the poor and promote the economic development of South Africa, because it would involve an increase in greenhouse gas emissions. I find such blind adherence to ideology (especially in the face of all the recent scandals that seriously undermine the science behind global warming) outrageous. It is also deeply troubling in its implications for our own economic development, since it betrays an obvious bias to put ideology first and the living standards of our citizens second.

Fear subsides, prices rise


A quick update on an enduring theme that has been one of the best explanations for how the recession of '08-'09 got started and how it ended.

A simple Irish solution to cutting deficits

Alex Pollock, writing in yesterday's WSJ, has a neat solution to cutting state, local, and federal government deficits. Cut government salaries. As Glen Reynolds notes, "if government workers know that proliferating deficits threaten their salaries, you turn them into a lobby for responsible spending." And as Mark Perry noted last month, this isn't a very draconian solution, since public sector workers already make a lot more than their private sector counterparts: "Total compensation costs for state and local government workers averaged $39.60 per hour worked in December 2009 (including benefits of $13.50 per hour), which was 44.5% higher than compensation for private industry workers."

Having had a long run of high growth and success, Ireland has now had a severe bust, the deflation of a housing bubble, and a financial crisis. Plus, its government is running big deficits. Sound familiar?

In response, the current Irish government budget takes these steps (translating from euros to dollars and rounding):

• Government employees' salaries up to $40,000 will be reduced by 5%.

• The next $54,000 of salary will be reduced by 7.5%.

• The next $74,000 of salary will be reduced by 10%.

When these tranches are added together, this gets you up to salaries of $168,000. Government salaries over this amount may be subject to marginal reductions of as much as 15%.

This looks like a very sensible plan for nonmilitary government employees.

Ireland has already worked out the plan. All the U.S. has to do is implement it.

Weekly claims: much ado about nothing


When I see this headline on Drudge—"Phone Home: Jobless Claims Rise Again"—I can't help but smile. Claims were about 25,000 more than expected last week, but that is no reason to think that the economy is suddenly in trouble. The claims series is notoriously volatile, bouncing around by 20K or 30K a week quite often. These blips need to be taken in the larger context of what is happening in the economy. The economy is making progress, and healing pretty much as it has in every recovery. This chart compares the level of unemployment claims to the number of people working. It shows significant progress, and a much lower level of workforce disruption (i.e., the percentage of the workforce that is laid off in a given period) than we saw in prior recessions.

Global equity rally marches on


According to Bloomberg's index, the capitalization of global equities has soared 88% from its low last year. That represents the creation (or re-creation I should say) of $22.6 trillion in wealth in just over one year. Another $14 trillion and we'll be back to where we started. The recovery from our global nightmare has been impressive and largely unexpected (except here on Calafia Beach), but it's not over yet.

Mark Perry has a nice list of "10 Reasons the Economic Recovery Is Real" that is worth checking out.

The Fed's absence hasn't affected mortgage rates


The Fed stopped buying mortgage-backed securities over a week ago, but the impact so far on the housing market has been negligible, as seen in this chart. Yes, yields on Treasury bonds have ticked up, but as of today the 10-yr Treasury yield is only 4 bps higher than it was at the end of March, which marked the end of the MBS purchase program. It's still possible that mortgage rates will edge higher, but at least now we know that this event was not a ticking time bomb for the housing market.

I and others had estimated that the end of the MBS purchase program might result in a 30-50 bps rise in mortgage rates relative to Treasury yields, but so far there is no sign of this occurring. The preliminary conclusion is that markets are and were operating in an efficient and rational manner. The end of the program was foreseen, and the market built that into prices, effectively discounting the event well in advance. In fact, 30-yr fixed rate jumbo mortgage rates today are only 4 bps higher than their all-time low (5.51%), which occurred in early 2004.

The commodity V-boom


The ongoing boom in commodity prices is just too big to ignore, especially when virtually all commodity prices are rising, and rising strongly, as this chart shows. This is big news, and it doesn't get enough attention.

Commodity markets are at the real-time intersection of global supply and demand, which in turn are influenced by the decisions of billions of consumers, millions of producers, millions of manufacturers, millions of speculators, and millions of hedgers. And their decisions, in turn, are influenced by the monetary policies of the world's central banks, the fiscal policies of the world's governments, and the behavior of the world's currencies.

Commodity markets are beyond the control of governments and bureaucrats. Commodity prices aren't subject to measuring delays, seasonal adjustments, or revisions. Nobody can corner the global market for commodity prices.

Commodity prices are the closest you can get to the vital pulse of the global economy. And the pulse is strong, very strong.

What exactly are the commodity markets telling us? For one, demand for commodities is outstripping supply. Global demand has bounced back strongly after almost shutting down in late 2008. That shutdown led to unwanted inventory accumulation among commodity producers, who then took steps to cut back on production, shutter mines, and cap wells. Now the producers are scrambling to get back on line, and having trouble keeping up.

Two, it's likely the strength in demand is being augmented to some extent (how much is anyone's guess) by easy money. Every one of the worlds' central banks is pursuing an accommodative monetary policy. (Some, notably the Reserve Bank of Australia, are worried that interest rates may be too low, but no central bank has yet adopted a policy calling for monetary restraint.) Easy money has a way of causing unease among the investing public which can manifest itself in an increased demand for tangible assets (real estate, buildings, and commodities, which are the building blocks of all the world's things) and a reduced demand for money.

This chart should be prominently displayed at every meeting of every board of governors of every central bank. Its message is clear: the time for easy money is past; it's past time to start raising interest rates. The global economy is unquestionably growing, and there's a danger that demand could be driven to excess by too much money. At the very least, there is not a scintilla of evidence in this chart of the economic fragility that would be the only justification for an extended period of exceptionally low interest rates.

And to reinforce this message, I would add this chart of the price of gold. I would love to hear a central banker try to dismiss the inflation implications of this chart for monetary policy. 

Oil price update






There's a wealth of information in these charts. The main message is that when energy becomes expensive, the US economy reacts by figuring out ways to become more energy efficient.

The first chart focuses on recent price action. Today's price of $87/bbl. is about eight times higher than it was in early 1999, but it is almost one-half of what it was (briefly) in 2008. Talk about volatility!

The second chart puts prices into a long-term, inflation-adjusted context. In this view, today's price is a bit less than the prices that prevailed in the early 1980s price shock, and we pay a lot more in real terms for oil than we did at any time prior to 1974. Oil today is "expensive" from a long-term historical perspective.

The third chart shows US oil consumption. Notice how consumption declines following periods when oil prices in today's dollars exceed $50/bbl or so. Also note how oil consumption accelerated in the 1990s when real prices averaged about $25/bbl. Oil is expensive at today's prices, and that is likely to constrain demand.

The fourth chart shows oil consumption per unit of GDP, which has fallen almost 60% since the first spike in oil prices. That's a textbook case of how people find ways to use less of something when its price becomes expensive. Today the US economy uses about the same amount of oil as it did in the late 1970s, but the economy is 125% larger! As a result, the US economy is far less dependent on oil, all without firing a shot at our OPEC "oppressors." (And by the way, if we are dependent on OPEC for a large portion of our oil purchases, they are just as dependent on us for a large portion of their income—it's a two way street with advantages and disadvantages for both parties.)

The fifth chart shows how much the typical consumer's budget is spent on energy. Consider that despite the approximately seven-fold increase in the real price of oil from 1960 to today, consumers spend about 25% less of their income on energy.

What is the upshot of all this? I think oil prices are still relatively high, and that is likely to result in continued conservation efforts. I don't think prices are high enough to cause a serious problem for the economy, because energy costs are not consuming an unusually large share of consumers' budgets. But I'm guessing that if prices rose above $100/bbl (roughly equivalent to $3.50-4.00 for a gallon of gas) then we would see a significant slowing in growth as a result, and frustrated consumers.

This further suggests that in order for a cap and trade scheme or a carbon tax to yield significant declines in our consumption of hydrocarbon fuels, policies would have to be geared to push the price of oil to at least $100/bbl. Meanwhile, however, our economy has done a tremendous job of becoming more energy efficient thanks to the workings of our free market system coupled with the magic of price signals, and it is likely to continue to do so if left alone.

Another commodity currency that looks overvalued


The comments in my previous post on the Canadian dollar and its valuation are also pertinent to this chart of the Aussie dollar. Both are commodity currencies, and both are riding high on stronger commodities and positive sentiment regarding their fiscal and monetary policies. Both are therefore vulnerable to any bad news.

Canadian dollar update -- caution warranted



The Canadian dollar has reached parity with the US once again. There's a lot going for it these days, and it shows, since the loonie is about as strong relative to the US dollar as it's ever been. That's the message of the first chart, which compares the spot price of the loonie (blue line) to my calculation of its purchasing power parity (green line). The gap between the two is pretty large, which suggests a significant "overvaluation" of the loonie.

The loonie has lots of fans because it is a "commodity currency" as the second chart shows. The loonie has traditionally been highly correlated to commodity prices, since Canada is a major producer of commodities. Commodity prices have been on a tear for over a year, and so has the loonie. Canada as a whole also looks pretty good relative to the US of late, since the country has largely avoided the banking crisis that the US is struggling with. (See this post which explains why: the Canadian government has for the most part avoided meddling in the housing and mortgage market.)

When the news is uniformly good, and the price of the beneficiary of the good news is historically high, that is the time to be cautious. Things might continue to improve, but then again they might not. At these levels, the loonie is very vulnerable to any news that is short of very good. It needs the good news to continue just to hold its current valuation. I'm not sure what might go wrong, but bad news has a tendency to come when you least expect it, and from a direction that nobody is watching. The loonie could go up some more, or it could hold at these levels for another year, and I wouldn't be surprised at all. But the risks are skewed to the downside in my opinion, so I would not want to be aggressively long the loonie.

Full disclosure: I have no exposure to the Canadian dollar at the time of this writing.

N. Atlantic shipping rates rising


For background on this relatively obscure index of shipping costs in the North Atlantic, see here and here. After spending a year at extremely depressed levels, it is now up over 20% from its year-end '09 lows as of last week. I don't know enough about this to say it's hugely important, but it can't be bad news, of that I'm pretty sure. The strength in the index also makes sense in the context of the ongoing signs of recovery in the US and most other economies around the world.

Why I still like AAPL (3)


AAPL is one of the few stocks to have reached new all-time highs in the wake of the Panic Recession of '08-'09. It peaked at $200/share at the end of '07, right on the eve of the recession, and it's up 18.5% since then. But in those 27 months the iPhone has become the dominant player in the global smartphone market—the one everyone wants to imitate—and Apple has developed and released the iPad. Apple also has gained significant market share in the laptop and desktop computer market. In fact, Apple now has a virtual lock on the high-end laptop market. The question of the day is whether the iPad will become the leader in, and rejuvenate, the tablet market. I think it will.

I received my iPad last Saturday, and I spent quite a few hours over the weekend playing with it and showing it to family and friends who came by to have a look at it. If my grandsons (ages 3 1/2 and 5 1/2) are any example, this thing is hot. So hot we had to tear it out their hands as they fought over the thing yesterday afternoon. Who would have thought, 20 years ago, that you could put the equivalent of what was then a supercomputer into a slab of glass and aluminum about the size of a small magazine, and that a toddler could pick it up and immediately start using it? It's simply awe-inspiring.

From my limited experience with the device, I have come to several conclusions. I think that just about anyone who picks up an iPad will marvel at its design and at the way it works. It's extremely fast and responsive; photos scale up and down instantly, and the screen rotates instantly. The eye candy is unending. It's gorgeous and it's sexy, and it's a must-have for gadget lovers. Apple has done a tremendous job with this.

The WSJ, New York Times, and BBC have done a superb job of presenting their content in iPad-friendly fashion. ABC allows you to watch their TV shows in HD after only a few seconds' wait. Netflix movies also pop up almost instantly and look terrific. The X-Plane flight simulator is absolutely breathtaking: choose from dozens of planes (even a 747) and locations, and fly by holding the screen in your lap and nudging and tilting it. Books are very readable, and now they can be interactive to boot. You can buy all sorts of things by just tapping your finger.

I'm still wondering, however, exactly how this device is going to fit into my daily life. It fits somewhere in the spectrum between an iPhone and a laptop, and it could replace either one or both, but not completely. It's a new type of computer, but you can't access the file system, and it won't let you print things directly (though I suspect that will come with time). You don't need to know anything about computers to use it, but if you know a lot about computers then you will wonder why it doesn't do some of things that all computers do.

It's designed to work best while sitting down as you would with a good book (physical books are now obsolete), but it's awkward to use at a desk. (That may change once I get the carrying case that doubles as a stand, and a wireless keyboard.) When they get cheaper I imagine people will buy several iPads and leave them lying around the house in different locations. It's ideal for surfing the web and showing people your pictures. It will go where laptops won't: to the bathroom, to the dinner table, or to the couch. It will be an essential traveling companion, since it's so much lighter yet almost as functional as a laptop for the majority of people. It will probably become even more functional than a laptop with time, since a good deal of the iPad's value will come from the tens of thousands of applications that have yet to be developed for it by smart people all over the world. Meanwhile, virtually all of the iPhone apps work on the iPad, but the good ones are going to have to be revised to take advantage of the iPad's bigger screen and much faster processor and much longer battery life. 

In short, there so many good things about the iPad that I can't believe it won't be a success. Defining where that success will come from, though, is difficult. This little gadget has tons of potential, and it can only add to Apple's bottom line. I continue to believe that Apple's future will be driven by an ever-expanding and innovative product line, and by an expanding share of the computer, laptop, tablet, and smartphone markets.

Full disclosure: I am long AAPL at the time of this writing.

Rising Treasury yields point to stronger growth


I've argued for awhile now that higher yields on Treasury bonds would not pose a threat to growth or to the stock market, since they would be a signal that the economic outlook was improving. This chart proves my point. 10-yr Treasury yields have increased about 80 bps since the end of last November, and real yields on 10-yr TIPS have increased by almost as much (67 bps). The difference between the two yields is the market's expectation for the average rate of consumer price inflation over the next 10 years (the breakeven inflation rate). Inflation expectations have increased only 13 bps in the past four months or so, even as yields have surged, which means that the rise in yields has been driven primarily by increased growth expectations.

This pattern—rising Treasury yields being matched closely by rising TIPS yields—could continue awhile longer. But before too long I would expect Treasury yields to rise much more than TIPS yields—and TIP yields to stop rising and begin falling, even as Treasury yields rise—as the market begins to realize that stronger and stronger growth brings with it more inflation risk. If nothing else, it should make you nervous today that the economic outlook is brightening but the Fed remains stuck on zero. As today's WSJ points out, Fed governors can't agree on whether inflation risks are rising or falling, so in the meantime they are doing nothing to reverse their quantitative easing. That makes it much more likely that they will fall behind the inflation curve as the economy picks up.


As this chart (above) shows, TIPS have gone from being quite expensive at the end of last November (1.1% real yields), to now being fairly valued according to my estimates. I doubt they will rise much above 2%, since at that point they would be getting increasingly attractive at a time when inflation fears would begin setting in; increased demand for TIPS would tend to push their prices up and their real yields down.

Full disclosure: I am long TIPS and TIP as of this writing, and short Treasury yields by virtue of having a 30-yr fixed mortgage.

Service sector recovering nicely


Calling this another V-sign of recovery might leave me open to more charges of being a cheerleader for the economy and having abandoned objectivity, so let me just say this chart shows that conditions in the service sector have improved quite a bit over the past year. Strength in the service sector is showing up across the board: in plans for new hiring, in new orders, in prices (see chart below), and in new export orders. And since the service sector is the largest sector of the economy by far, this is all very good news on the economic outlook front, and stocks are right to be cheering today.