Weighing the Week Ahead: It’s All about Earnings

by Jeff Miller

In last week's prediction for the week ahead my streak I guessed that the main theme would be whether we had dodged the bullet on the matter of a correction. This proved to be pretty accurate, despite news about China, the Bernanke testimony, and some big earnings numbers.

This week we have very little economic data and the Fed members are finally taking some time off from the speech circuit. It is one of the two biggest weeks of the earnings season, so I expect that earnings will be the key focus.

Here are some perspectives to consider.

• The Storytellers -- who can be of either the bullish or the bearish persuasion. The bears have emphasized the big misses in technology stocks. The bulls can point to strong reports from banks and health care companies. Anecdotal evidence is the raw material of confirmation bias, so watch out!
• The Data-driven – who analyze all of the results. The story so far is that companies continue to beat expectations on earnings while missing on revenues. This is turning into a multi-year story. As we always do during earnings season, we pay special attention to the updates from the Bespoke Investment Group.

• The Practical Forecasters. This group insists on looking beyond current revenue and earnings, emphasizing the outlook for company prospects. Nearly everyone following the earnings conference calls does this, but doing it for the market as a whole is almost a secret weapon. There is an excellent resource for looking beyond the current earnings reports, as I explain here.

I have some thoughts on the earnings season including a half-baked idea that I have never revealed before. I'll explain more in the conclusion.  First, let us do our regular update of last week's news and data.

Background on "Weighing the Week Ahead"
There are many good lists of upcoming events.  One source I regularly follow is the weekly calendar from Investing.com. For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world. It takes a little practice, but it is worth it.

In contrast, I highlight a smaller group of events.  My theme is an expert guess about what we will be watching on TV and reading in the mainstream media.  It is a focus on what I think is important for my trading and client portfolios. Each week I consider the upcoming calendar and the current market, predicting the main theme we should expect. This step is an important part of my trading preparation and planning. It takes more hours than you can imagine.

My record is pretty good. If you review the list of titles it looks like a history of market concerns. Wrong! The thing to note is that I highlighted each topic the week before it grabbed the attention. I find it useful to reflect on the key theme for the week ahead, and I hope you will as well.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.
Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
2. It is better than expectations.

The Good

This was a modicum of good news on the economic front.

• Moody's upgraded the U.S. debt outlook from negative to stable. Is this really good news? Please note below the impact of government spending on the economy. Who elected these guys to a position that would influence public policy decisions?
• The European story is better – more revenue, lower recession odds, and less threat to the world economy and US earnings. This is the story from Barron's. (Contrary view from Rebecca Wilder – and nice to see her writing again).
• High yield spreads are narrowing again. Bespoke provides analysis and the great charts you expect, including this one:

• Initial jobless claims moved lower, back into the recent range. This is an important indicator but difficult to interpret on a weekly basis. Seasonal adjustments are difficult for such a short time frame, especially when you get into the "retooling" season for auto companies. Scott Grannis has an alternative look that emphasizes the unadjusted data. It is easy to see the general level of improvement.

The Bad

There was a little bad news.  Feel free to add in the comments anything you think I missed!

• The CPI headline number was higher than expected. This subject is a huge source of misunderstanding on the part of the average investor. The magnitude of the difference is best understood if you realize that the Fed sees inflation as too low. Their preferred measure is currently showing a lower rate than the CPI. (See Dr. Ed for more). Explaining this is beyond the scope of my weekly article, but those who are interested in predicting Fed behavior should be paying attention. Doug Short has a nice continuing series on inflation which is also well worth reading.
• Gasoline prices are higher, influencing the CPI. The Bonddad Blog points to both higher oil and gas prices, asking "Why?" I think that it is a narrowing of the WTI/Brent spread, as noted by Bespoke (and various other sources). If this explanation is correct, we can expect gas prices to reflect fundamental changes in future months.
• Sentiment remains bullish. Bespoke notes that this contrarian indicator remains elevated after a "trivial" decline.

• GDP estimates are falling. Menzie Chinn at Econbrowser mentions the sequester and the increase in payroll taxes as causes. He also cites several other authoritative sources. Doug Short discusses the forecasts and shows the entire range of the WSJ economic panel in this chart:

• A technical signal from the High Low Logic Index is a warning of another 2007 (via Mark Hulbert). This approach is an element of and inspiration for the Hindenburg Omen, but does not seem to have so many false positive signals. On the other hand (via Mark Hulbert) none of the market timers he follows generate any edge on a long-term basis.
• Leading economic indicators were unchanged. This was below expectations so I am scoring it as "bad." Steven Hansen at Global Economic Intersection always has an interesting take, often by looking at the long term and avoiding seasonal adjustments. His analysis and charts help to put this report in perspective.
• Housing starts were very weak – much worse than expected. Calculated Risk keeps this in perspective by considering the multi-family effect and also building permits. Bill McBride is the go-to source on this subject, so I have special interest in his conclusion:   "Starts are moving up and completions are following.  Usually single family starts bounce back quickly after a recession, but not this time because of the large overhang of existing housing units." I continue to watch this very carefully. 

The Ugly

The Motor City. Matthew Dolan of the WSJ has a good story loaded with facts on the largest municipal bankruptcy. $18 billion in liabilities….

The Bond Buyer covers the implications ("ominous") for the muni market.

And what assets must be sold? Museum holdings? This car (original Mustang)?

Appreciation

My main reason for writing is pretty simple: I have an impulse to share a message that I hope some will find helpful. I did this for many years, partly as a way of communicating with clients. At some point, I started to get some inquiries from potential new clients. Many said that I was so low-key that they did not understand that I had investment services available! I have a good team, but not a special marketing departmentJ

1. I appreciate those who send an email with some kind words, or who make an encouraging comment. It lets me know that I am helping and offsets some of the "Miller, you idiot!" messages I get.
2. I appreciate those who consider our services, whether they choose us or not.
3. Thanks to Brian Gilmartin for his kind words on his excellent blog, Fundamentalis. He gives me too much credit merely for encouraging his efforts. He has a powerful, profitable message and a strong desire to share it. He is a natural writer.
4. And thanks also to Insider Monkey for including "A Dash" among the top 100 finance blogs. This is a real surprise. There is a formula for popularity and my relatively infrequent and skeptical long posts do not fit the bill. We are only at #89, but that leaves room for improvement.

The Indicator Snapshot

It is important to keep the current news in perspective. I am always searching for the best indicators for our weekly snapshot. I make changes when the evidence warrants. At the moment, my weekly snapshot includes these important summary indicators:

• For financial risk, the St. Louis Financial Stress Index.
• An updated analysis of recession probability from key sources.
• For market trends, the key measures from our "Felix" ETF model.

Financial Risk

The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has recently edged a bit higher, reflecting increased market volatility. It remains at historically low levels, well out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events.  It uses data, mostly from credit markets, to reach an objective risk assessment.  The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

Recession Odds

I feature the C-Score, a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."  I have now added a series of videos, where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50's.  I have organized this so that you can pick a particular recession and see the discussion for that case.  Those who are skeptics about the method should start by reviewing the video for that recession.  Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.

I have promised another installment on how I use Bob's information to improve investing.  I hope to have that soon.  Meanwhile, anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning.  Bob also has a collection of coincident indicators and is always questioning his own methods.

Meanwhile, here is the latest take from Bob's monthly take on the economy:

Bob's work is crucial to understanding why we are still early in the business cycle. Others look at elapsed time. Bob looks at data.

I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index.  They offer a free sample report.  Anyone following them over the last year would have had useful and profitable guidance on the economy.  RecessionAlert has developed a comprehensive package of economic forecasting and market indicators, well worth your consideration. Of special interest is the Leading SuperIndex, which accurately forecast the absence of a summer swoon. Since the weekly data are still mixed, it is important to monitor the index closely. Here is the most recent update and chart:

Georg Vrba's four-input recession indicator is also benign. "Based on the historic patterns of the unemployment rate indicators prior to recessions one can reasonably conclude that the U.S. economy is not likely to go into recession anytime soon." Georg has other excellent indicators for stocks, bonds, and precious metals at iMarketSignals. These all have recent updates.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverageof the ECRI recession prediction, now over 18 months old.  Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting.  His latest comment points out that the public data series has not been helpful or consistent with the announced ECRI posture.  Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.

The average investor has lost track of this long ago, and that is unfortunate.  The original ECRI claim and the supporting public data was expensive for many.  The reason that I track this weekly, emphasizing the best methods, is that it is important for corporate earnings and for stock prices.  It has been worth the effort for me, and for anyone reading each week.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions.  A few weeks ago we briefly switched to a bearish position, but it was a close call. Two weeks ago we switched back to neutral, which was also a close call. The inverse ETFs were more highly rated than positive sectors by a small margin, but remained in the penalty box. Last week we were almost in bullish territory, an amazing change in only two weeks. Last week I wrote that we were sticking with "neutral", but the bias was to the upside. This week the ratings have improved enough to warrant a bullish forecast.

These are one-month forecasts for the poll, but Felix has a three-week horizon.  Felix's ratings have improved quite a bit. The penalty box percentage measures our confidence in the forecast.  A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings.  That measure remains elevated, so we have less confidence in short-term trading.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list.  You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

This week brings little data and scheduled news, an artifact of the calendar and the holidays.

The "A List" includes the following:

• Initial jobless claims (Th).   Employment remains the focal point in evaluating the economy, and this is the most responsive indicator.
• Michigan sentiment index (F). This remains a good concurrent indicator for employment and spending. This is the final reading for July, but it sometimes differs significantly from the preliminary report.
• Existing home sales (M). Housing remains as a crucial driver for the U.S. economy.

The "B List" includes the following:

• New home sales (W). Important, but less interesting than permits
• Durable goods (Th). More interesting than normal given the low GDP.

And especially – Earnings!

A quiet time on the Fed speechifying front.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has moved to a bullish posture, now fully reflected in our trading accounts. We have maintained our long position in oil and also added two equity ETFs. Felix did well to avoid the premature correction calls that have been prevalent since the first few days of 2013, accompanied by various slogans and omens. Felix has dodged some of the market volatility, profited from a short bond position, and made gains in oil (via USO).

Insight for Investors

This is a time of danger for investors who are stubbornly sticking to losing ideas. This was the subject of some great posts last week.

Abnormal Returns wrote about those who have missed the rally, citing several other helpful articles. Here is a key quote:

…(W)e investors have a tendency to personalize these things. The past five years has been a difficult for investors. Especially for those investors who have fought the rally all the way higher. Those who did so have often been enamored of one theory or another on why the economy (and stock market) were headed for a fall. Unfortunately the market doesn't care about your theories.

I encourage reading the entire post and all of the links cited. This is a great way for those who have missed the rally to gain a new perspective.

Meanwhile, our readers with a long-term perspective should find this approach as quite familiar. If you have followed our indicators on earnings, recession risk, and the St. Louis Financial stress index you have had a much more constructive viewpoint. If you follow Bob Dieli's business cycle work, you have a special edge.

My recent themes are still quite valid. If you have not followed the links below, please find a little time to give yourself a checkup. You can follow the steps below:

• What NOT to do

Let us start with the most dangerous investments, especially those traditionally regarded as safe. Interest rates have been falling for so long that investors in fixed income are accustomed to collecting both yield and capital appreciation. An increase in interest rates will prove very costly for these investments. It has already started. Check out Georg Vrba's bond model, which continues to signal the risk. Other yield-based investments have also suffered, and it is not over. Check out the latest interest rate forecast from LearnBonds. Or the timetable to a 4% ten-year note from Goldman Sachs (via Joe Weisenthal).

• Find a safer source of yield: Take what the market is giving you!

For the conservative investor, you can buy stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%. The risk is far lower than for a general stock portfolio. This strategy has worked well for over two years and continues to do so. I have had a number of questions about this suggestion, so I recently wrote an update. That post provides background as well as concrete examples showing how you can try this strategy yourself. There is nothing quite as satisfying as watching your account grow while the market is doing nothing or trading in a range.

• Balance risk and reward

There is always risk. Investors often see a distorted balance of upside and downside, focusing too much on news events and not enough on earnings and value. You need to understand and accept normal market volatility, as I explain in this post: Should Investors be Scared Witless?

• Get Started

Too many long-term investors try to go all-in or all-out, thinking they can time the market. There is no reason for these extremes. Recent weeks have been tough for traders. Most were surprised by the market reaction to more FedSpeak and the spike in interest rates.

For investors it was a different story. If you had your shopping list, there have been good opportunities to buy stocks. For those following our enhanced yield approach you had both the chance to set new positions and to sell calls against old ones. This week's Barron's has a nice list of inexpensive stocks. You need a subscription or to purchase a copy, but I like the list --- perhaps because we hold three of the seven stocks mentioned!

And finally, we have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love feedback).

Final Thought

I have no special insight in how the rest of the earnings season will play out.

Regardless of the current results, we will soon enter a period of seasonal strength. The "sell in May and buy in October" meme defies logic. Most good investment ideas disappear. When they are known, people follow them.

Here is a clue about why seasonality works. This is a quotation from Andrew Bary in this week's Barron's

"The S&P 500 trades for about 15 times projected 2013 profits and 14 times estimated 2014 earnings. Small-cap indexes have higher valuations, with the Russell 2000 index fetching about 17 times projected earnings in the coming year. The S&P 500 is up 18% this year and the Russell, 24%."

It is July, so he is citing a multiple for both 2013 and 2014. In a few months no one will talk about the 2013 multiple; they will all look ahead.

This may seem silly, but I have watched it for two decades. Earnings are reported and summarized by calendar years, and that is how they are discussed. At some point, if earnings are growing (as is usually the case) the market just seems cheaper since the multiple is for the next year. You can gain a solid advantage by always using a 12-month forward earnings approach, as I describe here. I also do this with my individual stock analysis.

I expect the market to digest the current numbers, but also to look beyond the current earnings season.

See the original article >>

Diverging fund flows are reflected in fixed income performance

by SoberLook

Capital is returning to certain fixed income sectors. Fund flows are quite uneven however, with the corporate sector remaining investors' favorite. In particular, high yield bonds have recouped a great deal of the recent outflows.

Source: Goldman Sachs

In contrast, mumi bonds have seen almost no new net inflows. The little problem in Detroit is not helping the situation (see story) and the SEC going after the city of Miami (see story) has made the sector look quite unappealing.

Source: Goldman Sachs

Outside of treasuries, fixed income performance these days is extremely sensitive to fund flows. And the returns over the past month (June 20th - July 19th) fully reflect these dynamics in mutual funds and ETFs.

See the original article >>

Stock Market Uptrend May be Topping

By: Tony_Caldaro

The market started the week by making a new uptrend high on Monday, pulled back, made a new all time high on Thursday, pulled back, then ended the week within one point of the all time high. For the week the SPX/DOW were +0.60%, the NDX/NAZ were -0.75%, and the DJ World index gained 1.0%. Economic reports returned to a positive bias this week. On the uptick: retail sales, the NY/Philly FED, business inventories, the CPI, industrial production and capacity utilization, the NAHB housing index, and weekly jobless claims were lower. On the downtick: housing starts, building permits, the M1 multiplier and the WLEI. Next week more housing reports, durable goods orders and consumer sentiment.

LONG TERM: bull market

The market ended the week within one point of the all time high established on Thursday at SPX 1693. The bull market continues. Unfortunately, as we have been reporting, the US is one of the few, if not the only, bonafide bull market of the twenty international indices we track. When this bull market starts to stumble the thud will be heard worldwide.

We continue to count this bull market as Cycle wave [1] of Super cycle wave 3. Super cycle bull markets last 70 – 80 years. But Cycle [1] bull markets typically last about five years. We continue to expect five Primary waves to conclude before this bull market ends. Primary wave I and II completed in 2011, and Primary III has been underway since then. Primary I divided into the typical five Major waves, but had a subdividing Major wave 1. Primary III is also dividing into five Major waves, but both Major 1 and 3 are subdividing into five Intermediate waves.

Major waves 1 and 2, of Primary III, completed by mid-2012. Major wave 3 has been underway since then. Intermediate waves i and ii completed by late-2012, and Int. waves iii and iv completed by mid-2013. Intermediate wave v, of Major wave 3, of Primary III is currently underway. When this uptrend concludes a Major wave 4 correction will follow, and the market should lose about 10% of its value. After that we expect a Major wave 5 uptrend to new highs, concluding Primary wave III. Then after a Primary wave IV correction, a Primary wave V uptrend to new highs should complete the bull market. We continue to target the bull market conclusion by late-winter to early-spring of 2014.

MEDIUM TERM: uptrend

When this uptrend began at SPX 1560 in mid-June we projected a minimum target of the 1680 pivot for Minor wave 3, and the 1699 pivot for Minor wave 5. These targets were met this week when the SPX entered the 1699 pivot range. We had also projected a July uptrend high would probably end at the 1699 pivot, or an August uptrend high at the 1779 pivot. The question on some traders minds; “Is the market topping here, or preparing to extend into August?”

During the week we posted three potential short term counts to address this question. One of the three has already been eliminated. This leaves us with two potential counts: one posted on the SPX hourly chart, and the other on the DOW hourly chart. Both counts, as of Friday’s close are still valid. The SPX count suggests the uptrend is in the process of a forming a top. The DOW count suggests the uptrend will probably extend into August. The internal wave structure of this uptrend and the technicals, are the keys to this inflection point. Medium term support is at the 1680 and 1628 pivots, with resistance at the 1699 and 1779 pivots.

SHORT TERM

From the SPX 1560 Intermediate wave iv downtrend low we counted five waves up to SPX 1627, then a three wave pullback to 1605. This completed Minor waves 1 and 2. After that the market rallied quite strongly, in a five wave sequence, to SPX 1685. This could have ended Minor wave 3. The pullback that followed, however, was smaller than the 20+ points expected for a Minor wave 4 (1685-1672). From that low the market rallied to SPX 1693, and then pulled back on Friday to 1684 for another small pullback. During an Int. wave i or wave iii uptrend, we would consider this normal Minor wave 3 activity. However, since there have be several shortened fifth waves during this bull market. We can not assume this fifth wave will follow normal uptrend activity.

During this uptrend the smaller pullbacks, and there have been quite a few, have declined between 9 and 13 points. Minor wave 2 stands out as a 22 point pullback. From the Minor wave 2 SPX 1605 low the market has advanced into Friday’s close with four small pullbacks between the same 9 and 13 points. Normally, we would consider this rally an ongoing Minor wave 3. In fact, should the SPX rise above 1693 we would count this advance as an ongoing Minor wave 3. The count posted on the DOW charts. If it fails to clear SPX 1693, then the count posted on the SPX charts, a potential uptrend high, becomes the probable count.

Technically there are some negatives supporting a potential uptrend high scenario. The SPX/DOW have met the minimum requirements to complete this uptrend, and there are negative divergences on most timeframes. A strong rally, however, would clear them away. Currently, we would put the probabilities for the two scenarios at 50-50. Short term support is at the 1680 pivot and SPX 1658-1667, with resistance at the 1699 and 1779 pivots. Short term momentum ended the week overbought. The short term OEW charts remain positive with the reversal level now SPX 1675.

FOREIGN MARKETS

The Asian markets were mostly higher gaining 0.2% on the week. Australia, India and Japan are in confirmed uptrends.

The European markets were mostly higher gaining 1.9% on the week. England, France, Germany and Switzerland are in confirmed uptrends.

The Commodity equity group were all higher on the week gaining 3.3%. Canada and Russia are in confirmed uptrends.

The DJ World index is uptrending and gained 1.0% on the week.

COMMODITIES

Bonds continues to look like they are beginning to uptrend gaining 0.7% on the week.

Crude remains in an uptrend since April gaining 1.8% on the week.

Gold continues to work its way higher gaining 0.9% on the week.

The USD may be downtrending again losing 0.3% on the week.

NEXT WEEK

Monday we have Existing home sales at 10:00. Tuesday: FHFA housing prices. Wednesday: New home sales. Thursday: weekly Jobless claims and Durable goods orders. Friday: Consumer sentiment. A quiet week, with a quiet FED, ahead of the FOMC meeting on Tuesday/Wednesday of the following week. Best your weekend and week!

See the original article >>

Any Bonds Today?

By: John_Mauldin

By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls . . . become 'profiteers', who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished not less than the proletariat. As the inflation proceeds . . . all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless…. – John Maynard Keynes

One of the more frequent and important questions I get asked when I travel is whether I think we will see inflation or deflation. My usual flippant answer is "Yes," and then I go on to explain that there is no simple answer. Over what time period? In what country? And by what means do you want me to measure inflation or deflation? Today we take a look at part of a white paper I am working on with Jonathan Tepper, the co-author of Endgame, on this topic. I think you will find it interesting reading on a summer's day. And I have to quickly mention the absolute disaster that is happening before our eyes in the labor market. Our kids are getting skewered (the polite word) by unintended consequences of the Affordable Care Act. We need a bipartisan fix quick, before we damage an entire generation.

But first, let me call your attention to a dynamite conference at which I'll be speaking in October. It's "3 Days with Casey," the Casey Research Summit for 2013, to be held October 4-7 in Tuscon, Arizona. In addition to the indomitable, incredible Doug Casey, my friends Ron Paul, Lacy Hunt, Rick Rule, and Don Coxe will all stand and deliver, along with a bunch of other outstanding speakers, including Jim Rickards (author of Currency Wars), Paul Brodsky (I love this guy's stuff!), and Chris Martenson (author of The Crash Course). And of course you get the whole Casey research team. Thoughts from the Frontline readers can get a special early bird discount here. Come help me celebrate my 64th birthday!

A Temporary Problem

Back in 2010, a number of analysts (including me) noted an unintended consequence buried in the Affordable Healthcare Act (aka ObamaCare). Employers are not required to provide insurance for temporary workers, and a temporary worker is defined as someone who works under 29 hours per week. Many of us noted that this would result in businesses shifting workers from full-time to part-time. The answer from AHA supporters was that "No, it wouldn't" or that the effect would be small. There was no real way to know, of course. I and others could only point to our experience of how the real world works. If you defined the cut-off for part-time work at 35 or 39 hours a week instead of 29, the economics of ObamaCare simply got blown out of the water. But the bill passed, and now it's law.

And now the argument is over. It is clear that businesses have indeed responded to the rather perverse incentives in the law. A year ago, growth in full-time employment far outpaced increases in temporary employment. That trend has reversed this year. Mort Zuckerman wrote in an op-ed piece in the Wall Street Journal this week:

The jobless nature of the recovery is particularly unsettling. In June, the government's Household Survey reported that since the start of the year, the number of people with jobs increased by 753,000 – but there are jobs and then there are "'jobs."' No fewer than 557,000 of these positions were only part-time. The June survey reported that in June full time jobs declined by 240,000, while part-time jobs soared 360,000 and have now reached an all-time high of 28,059,000 – three million more part-time positions than when the recession began at the end of 2007.

That's just for starters. The survey includes part-time workers who want full-time work but can't get it, as well as those who want to work but have stopped looking. That puts the real unemployment rate for June at 14.3%, up from 13.8% in May.

The US Chamber of Commerce summarizes the situation:

"Small businesses expect the AHA requirement to negatively impact their employees. Twenty-seven percent say they will cut hours to reduce full-time employees, 24 percent will reduce hiring, and 23 percent plan to replace full-time employees with part-time workers to avoid triggering the mandate."

Younger people and those whose jobs could readily be farmed out to plenty of potential replacements are in danger. There are many jobs that can almost as easily be done by two people working 20-25 hours as by person working 40-50 hours. And that is what is happening. As Zuckerman notes, if you count those who have only temporary employment though they want full-time work, the unemployment rate rose last month from 13.8% to 14.3%. This is recovery?

I have seen this happen in my own family (and to a union member, no less!). How can you support yourself on a part-time job? Juggling two part-time jobs takes a lot more than 40 hours a week and increases the costs of getting to and from work. And under the AHA, the government, not the employer(s), is going to have to pick up that bill if a part-time worker is going to have health insurance.

Republicans want to repeal ObamaCare. Many are not interested in anything short of that outcome. Democrats don't want to change anything and won't touch legislative fixes, afraid to be seen as opening up the whole issue before the next mid-term elections. But we are seriously damaging the ability of people to get work and be able to support themselves and especially the opportunity for younger people to get work that can result in acquiring skills and moving upward on the income scale. The definition of part-time should revert to the traditional standard: if you work less than 40 hours a week, you are part-time.

I get that that destroys the economics of ObamaCare. But do we want to see our children as unintended casualties in a political war over healthcare? A bill has been introduced to fix this problem in the Senate. The US Chamber of Commerce survey is telling us the direction we are currently headed in. Do we really want to wait until things get even worse?

And now, let's think about inflation, together with my co-author, Jonathan Tepper.

Any Bonds Today?

Can you imagine Julia Roberts and Gwyneth Paltrow helping the US government sell bonds or Jay Z and Justin Timberlake composing songs about Treasury bills? It would not be the first time Hollywood stars or famous musicians tried to help the government sell its debt.

The last time the US government had an enormous load of debt, it used Hollywood stars to help sell government debt. The Treasury Department conducted a massive public relations campaign through radio, newspapers, and film. During World War II, war bond rallies were held throughout the country, and Hollywood stars such as Bette Davis and Rita Hayworth traveled around the country to promote war bonds. The great Irving Berlin even wrote a song titled "Any Bonds Today?" and Berlin's tune became the theme song of the Treasury Department's National Defense Savings Program.

The government also enlisted cartoon characters, actors, comedians, and musicians to encourage people to pay income taxes. Donald Duck told viewers it was their "duty and privilege" to pay income tax. Abbott and Costello appeared in advertisements to get people to pay taxes, and Irving Berlin wrote songs not only about bonds but songs about taxes like "I Paid My Income Tax Today."

While the war bond and income tax drives garnered all the press, the real reason the US was able to borrow so much and with so little burden had nothing to do with the glitz and glamor of movie stars. The US government borrowed easily because the Federal Reserve printed money to keep interest rates low. Borrowing is very easy when a central bank has your back.

How did it work in practice? As is the case today, the Treasury wanted to borrow cheaply then, and the central bank was happy to accommodate. In 1942, after the United States entered World War II, the Federal Reserve officially agreed to fix interest rates on government bonds at a low level. To maintain the pegged rate, the Fed was forced to give up control of the size of its balance sheet. Unsurprisingly, the Fed bought and held all available short-term US treasuries and almost all long-term government bonds.

The costs of paying for World War II pushed the national debt up sharply, from around 40% of GDP before the war to a peak of nearly 110% as the war ended. But a combination of strong economic growth, tight fiscal policies, and financial repression brought the debt back below 50% of GDP by the late 1950s. (Currently our government debt has reached about 90% of GDP and continues climbing very sharply.)

During the war years, the Federal Reserve pegged long-term interest rates at extremely low levels so the government wouldn't have to pay much to fund itself. To make sure that inflation didn't spike, the government instituted wage and price controls. After the war, the price controls disappeared and inflation rose very quickly, averaging about 6.5 percent annually from 1946-51. By the postwar price peak nine years later, wholesale prices had more than doubled, and the stock of money had nearly tripled.

Normally, such high inflation would have made it much more expensive for the government to borrow money. But after being pressured by the Treasury, the Federal Reserve agreed to keep on pegging long-term government bond yields at 2.5% until the spring of 1951, when the Federal Reserve finally refused to print money to keep bond yields low. Because of the coordination between Federal Reserve and the US Treasury, real yields on government bonds were very negative during the years following World War II. With negative real yields, borrowers win and lenders lose. The clear winner was the US government, and the loser was anyone who bought and held US bonds. The combination of very low government bond borrowing costs and high inflation ate away a sizable chunk of the government's debt burden.

The same thing is happening today in almost all government bond markets around the world. Governments are winning, and investors are losing. The Federal Reserve is helping the Treasury to borrow cheaply while the government expands its deficit spending and debt accumulation. Using inflation and low bond yields this way to reduce government debt is called financial repression.

The government and central banks also contribute to higher inflation by pretending inflation is always under control. For example, throughout the Greenspan and Bernanke years, the Fed consistently chose to focus on lower inflation measures whenever doing so suited the central bank. You can see this in the semiannual monetary policy reports to Congress, specifically in the inflation forecasts made by the members of the Federal Open Market Committee. Until July 1988, inflation forecasts used the implicit deflator of the gross national product, but then the Fed switched to the Consumer Price Index. In February 2000, the Fed replaced CPI with the personal consumption expenditures (PCE) deflator. Thus from July 2004 onward, inflation forecasts have employed the core PCE deflator that excludes food and energy prices. Using lower and lower, less comprehensive estimates for inflation has allowed the Fed to pretend that it is meeting its mandate – but by ignoring high in flation readings. In the meantime, interest rates have been kept too low, and the inflation rate has consistently remained above the Federal Funds rate.

But measuring inflation is not so easy. The vast majority of readers have no idea about the rather contentious nature of the debates that go on in academic conferences about arcane topics such as the minutiae of how to measure some minor aspect of inflation. Passions run deep. Careers are made. Once you delve into how things are actually done, you realize that what we think of as an inflation number is actually an approximation of an idea the very definition of which can change over time.

Your perception of inflation (and everyone else's) has a very close relationship to how stock markets perform over time. Indeed, one of the questions we are both regularly asked wherever we speak is something along the lines of "What do you think inflation or deflation will be?" And the answer is not easy: it depends on a number of factors that vary from country to country.

In general, the trend for the last 75 years has been one of inflation. Sometimes, in some countries, inflation has spun out of control. At other times you see outright deflation. Neither one promises good times for investors. Ever-falling inflation or low inflation is the best environment for investing. But given the paramount importance of the inflation/deflation debate, we need to briefly investigate what inflation is and is not.

There has been a great deal written about the difficulty of measuring inflation and about the potential manipulation of inflation statistics over the last 30 years. John Williams of ShadowStats is the most-noted proponent of the position that inflation is running well above the current US government's number of 2% (for the 12 months ending February 2013).

Employing the methodology that was used in 1980 under the Carter administration, inflation would currently be about 9.6% (see chart below). Using the government methodology from 1990, inflation today turns out to be a little under 6%.

(Fair warning: The following will be regarded as a contentious statement by the gold bugs and hyperinflationists out there. For some of you, to accept it would be like admitting your religious beliefs are wrong.)

The topic of those alternate inflation numbers comes up often at our tables of conversation. Generally it seems to be clear that the methodologies used in 1980 and 1990 are visibly, patently, demonstrably wrong. If inflation were now at 9.6%, then interest rates should be closer to 12% and not the 1.75% we see on the 10-year Treasury today (more on that topic in a minute), no matter what the Fed wanted, unless they were willing to monetize not only new debt but any existing debt that got rolled over as well. Over time, markets respond to actual inflation and not government statistics. Argentina's government can state that inflation is "only" 10%, but the market thinks it is 30% and rising.

The government calculation of inflation in 1980 or 1990 was the best they could do at the time. Gentle reader, it was a government calculation. There is nothing ex cathedra about either methodology. In religious terms, neither rises to the stature of the original Greek documents or the Latin Vulgate Bible. Changing the words (the equations) in economics should not be seen as somehow equivalent to changing the fundamental documents of a religion. There is nothing sacred about 1980 CPI methodology, and in fact we can look at it empirically and understand that it was pretty flawed.

You might have some personal investment bias (read "quasi-theological reason") to want inflation to be high. But that is a belief system. It is one form of faith-based economics (It is not a large stretch to suggest that most economic schools require of their adherents a measure of faith and belief). Expectations of high inflation are for some people a basic tenet of their belief system. Saying there is only a little inflation must therefore be a government manipulation.

We must constantly be comparing our assumptions against what we observe in the real world, in order to discern where our models, with their built-in assumptions, bias our conclusions about what the data says.

If you think overall general inflation is high, then you have to think the entire world is delusional. (Note: your personal inflation rate may be much higher than 2%.) G-7 interest rates are at an all-time low today. That can and will change; but right now the bond market does not see inflation as a problem anywhere in the developed world, although Japan has now made what must be their 10th vow in the last 20 years to create inflation. This time, they may actually (for them, catastrophically!) succeed. For now, however, deflation and deleveraging are the order of the day.

If we had kept the methodology used until 1980 for calculating the Consumer Price Index and then used that number to adjust Social Security and government pensions, the US government would be bankrupt today. Social Security would have gone negative in the 1990s and tripled in cost in the last 12 years (compounding at 10% can do that). Now, those of you living on Social Security might think a tripling of payments is appropriate, given what has happened to your budgets, but younger taxpayers would hasten to differ. (Note: we are not arguing that SS provides a livable income at current levels. Different topic for another paper.)

All this is not to say that today's inflation methodology is correct or gives us a number that is accurate. It is simply better than the methodology used in 1980 – but it is still just a statistical method that tries to reach for the impossible, all-illumnating star of reliability and finally has to settle for accuracy in general at the risk of imprecision in the particulars. We will be able to look back in 15 years to see how well we are doing today at measuring inflation. The real surprise would come if we don't change methodologies at least a few more times between now and 2030.

It is hard to argue with people who point out that prices and the cost of living are going up faster than government-reported inflation reflects. We can all see prices rising. Food, energy, tuition (try managing all that for 30 years with seven kids!) – they're all going up. If we had used actual home prices in the CPI, inflation would have been seen as very high in the middle of the last decade. Instead, we seemed to be flirting with deflation; and if we used housing prices in 2008-2011, we would certainly have had government-reported deflation. In place of home prices, the Bureau of Labor Statistics decided to use something called Owners' Equivalent Rent a few decades ago; and it is the largest part, a full 24%, of the CPI. Something called hedonics is probably the most contentious part of the CPI calculation. The BLS says, "The hedonic quality adjustment method removes any price differential attributed to a change in quality by adding or subtract ing the estimated value of that change from the price of the old item." This is not as mysterious as it sounds. When, for example, you replace your old computer with a new one, paying roughly what you did before, the new model you buy is always faster and more powerful than the old one. The BLS says you are getting more for your dollar; therefore the price fell even if you paid as much or more for the new computer. Opponents say hedonics can be used to hide "true" inflation.

We do know that a lot of items have in fact gone down in price and up in quality or capacity. Cell phones are a good example. And the cost of using cells may be ready to really fall. There is a full smart phone that uses a major carrier and Wi-Fi in combination now on the market for $20 a month for all the voice, data, and text you can eat. It works on Wi-Fi in Asia, in Europe, and in the middle of the Andes. You pay basically nothing for 10 or 15 or 40 hours a week of talk time, and people can call you anywhere in the world using a local US number if you are connected to Wi-Fi.

Most egregiously for many, the CPI also does not take into consideration income taxes. For a number of people, taxes are their largest source of inflation!

Yet all of us here in the US are governed by the same people in Washington, and they define inflation in their own way, via the Consumer Price Index and various related benchmarks. Because CPI tries to find a national "average" inflation rate, it is almost by definition inaccurate for any given person, family, business, city, or state. CPI is the least common denominator, a "one size fits all" coat that in reality fits no one very well. (For the record, all the data used to calculate inflation is public. You can calculate inflation for your own local area if you have nothing better to do. In fact, the entire methodology is public, if a little dense.)

Given the acknowledged limitations of the CPI, we nevertheless use it in myriad ways. It governs cost-of-living adjustments for Social Security beneficiaries, government employees, and many labor union members. CPI is baked into the general cake, even though we know it is an imperfect fit in almost every situation.

As a result, some people get raises when their cost of living drops, while for others the cost of living rises faster than their income does. Is this fair? No. Is there a better way? We don't know what it would be. There are hundreds of smart people who build entire careers trying to answer that question.

Other inflation measures exist, but they all have their own limitations. Three Federal Reserve Bank regions calculate their own versions of CPI. The Federal Reserve itself prefers to look at something called PCE, or Personal Consumption Expenditures, a measure which uses chained dollars rather than a fixed basket as the CPI does. Since 2000, the Federal Reserve has used PCE in its reports to Congress about expectations for inflation.

In explaining its preference for the PCE, the Fed stated:

The chain-type price PCE index draws extensively on data from the consumer price index but, while not entirely free of measurement problems, has several advantages relative to the CPI. The PCE chain-type index is constructed from a formula that reflects the changing composition of spending and thereby avoids some of the upward bias associated with the fixed-weight nature of the CPI. In addition, the weights are based on a more comprehensive measure of expenditures. Finally, historical data used in the PCE price index can be revised to account for newly available information and for improvements in measurement techniques, including those that affect source data from the CPI; the result is a more consistent series over time. ("Monetary Policy Report to the Congress," Federal Reserve Board of Governors, Feb. 17, 2000)

Contentious? You bet! PCE and other chained inflation numbers generally yield lower inflation figures, which is why many in Congress (and the AARP) think the "chained dollars" amount to some sort of conspiracy to defraud seniors on Social Security. CPI is used to calculate adjustments for income taxes. If it is too low, then incomes rise faster in real terms than cost adjustments do, and that acts as a tax increase even as your pension is adjusted lower. But if inflation is calculated too high, then taxes are lower than they would otherwise be and the costs of Social Security and pensions are higher. Talk about using a sledgehammer to fine-tune a highly developed economy. Even small miscalculations will add up over time to large losses for someone. Ouch!

Newport, NYC, Maine, and Montana

I head off to Newport, Rhode Island, on Sunday to spend a week in a workshop for the Department of Defense at the Naval War College there. Basically, they gather 12 or so experts in a wide variety of fields to sit down with people from the five branches of the military who are responsible for future planning (utilizing both the hard and soft sciences). They ask us to come up with a set of future scenarios that are outside the current mainstream consensus but that the Defense Department might need to consider in their planning. I am not exactly sure why I get invited, but it's a week of mind candy for me. When I was first asked, I wondered how much it would cost me. I actually get a government stipend and my room and board. They do work your derriere off, but it's worth it. (Google "Andrew Marshall and the Office of Net Assessment." Marshall is 91, was appointed by Nixon to head the Office of Net Assessment, and has been reappointed by every president since then. It is an honor to be in the same room with him. I recently taped an interview with Andrew on how he goes about thinking about the future, and at some point I'll make it public.)

After a week in Newport, I go to NYC for a few days of meetings and work on projects before I head to Maine for the annual fishing trip (Camp Kotok at Leen's Lodge in Grand Lake Stream) the following week. That Friday (Aug. 2) I will likely be on Bloomberg in the morning, live from Maine, at about 9 AM. It will be Jobs Report Friday, so that is usually the topic of conversation. I will note more on that schedule next week. Then I am home for a week before I head to Montana for four days of R&R at the lake home of my good friend Darrel Cain.

For those interested, I recently did an interview with Eric King on King World News. You can listen in at http://tinyurl.com/m5d97h7.

It has been a busy week as I play catch-up with the commitments and reading I got behind on while I was sick. I am now fully recovered, although I can't do 50 push-ups yet. That is my personal marker for being back. I'll get there. Have a great week!

Your worried about jobs for the kids analyst,

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Gold Daily and Silver Weekly Charts - Reuters Says Gold Demand Outpacing Supply

by Jesse

"The current dislocation indicates that holders of gold futures have begun demanding delivery. But because of the large amount of leverage in the market, participants are not able to deliver on their obligations."
Reuters, Gold Futures Hiccup Indicates Demand Outpacing Supply

This is not news to anyone who has been frequenting this café.  But it is nice to hear it from another source.
The market structure in gold and silver is truly fascinating, particularly if one is looking slightly cross market at the mining sector.
One would hope that the miners would not be driven back into hedges by short term cash requirements at this price level, as they may find it to be fairly uncomfortable in the intermediate term.
And I would not be likely to invest longer term in a miner that was hedging its future ahead of what looks to be the next leg of the bull market. 
That is almost as bad as having a money manager keeping you short into what looks like a very risky set up to the upside. Not my cup of tea.  I wonder if we will see a limit up day or two before this is over. I cannot remember the last time that occurred.
There was commentary on the levels of registered gold at the COMEX that you may find to be of interest.
The market structure indicates that someone is going to be left 'holding the bag' on the short side. But who can say with any certainty given the growing divergence between the paper pricing and the physical reality?  We are in a currency war after all.
The Gold Forwards were negative for the tenth straight day.   Listen to this, and understand what it means. 
In their article about the 'hiccup in gold futures indicates that demand is outstripping supply' for physical bullion Reuters goes on to say:

"A dislocation in the gold futures market indicating that demand for physical delivery of the metal is now far outweighing supply has intensified in recent weeks, increasing concern in the market that the change may not be a momentary blip and participants may have become over-leveraged."

I think this deserves some serious attention.   I would not care to be short the metal, and face any requirements to have to deliver on demand.  It could prove to be costly. 
But again, these markets are so twisted that I don't think it is too much to say that almost anything can happen.  A 'crash' in equities would put a dent in almost any asset sector demand.   But those tend to be less probable events that are amenable to some rudimentary insurance for those with shorter term horizons. 
Have a pleasant weekend.  See you Sunday evening.

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Stock Market Divergences Continue Whilst VIX Drops

By: Jesse

"I listened carefully to yesterday's Bernanke speech. He seemed ill at ease and almost stumbling. I truly believe that Bernanke is confused and even frightened by the results of all his manipulations. But what he's most confused about is the poor results he's been getting from both the economy and the markets. Bernanke appears to me to be a man trapped and confused by his own unorthodox tactics." - Richard Russell July 18, 2013

Bernanke is bewildered by the power of the credibility trap, and the ensuing unresponsiveness and inattentiveness of the Federal government to the problems of the people and the real economy. At least that is my opinion, and I could be wrong.

The divergence between finance and the real economy continued. The SP 500 closed at another new high, even as tech floundered due to poor financial results in the leaders.

VIX has now dropped to levels in which it could once again be a productive hedge against a market decline.

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