Wednesday, May 18, 2011

The 2 indicators to watch out for

Do you feel overwhelmed by the flood of economic metrics? Probably not since most laymen have come to shrug off the meaningless numbers. The numbers only matter to policymakers who only look out for positive news. Any negative news are dismissed as noises.

Indicators or metrics are important but most are red herring. If you pick up the wrong ones, you'll be misled all the way like most political leaders and economic policymakers. Business leaders or managers also rely a lot on them and most got flummoxed by their underlings who manipulate the numbers, euphemistically termed Key Performance Indicators (KPIs) in the corporate world.

Even profits could be massaged by bean counters who exploit their knowledge of accounting standards to bypass expenses out of the income statement straight to the balance sheet but always channel income through the income statement. Aside from accountants, you should also always be on guard when dealing with lawyers. Both relish wallowing in grey areas, one with numbers, the other with words. God help you should you happen to have dealings with an accountant-cum-lawyer.

So what choice do we have? The most important rule is to know what patterns need to be monitored. This depends on the situation in hand. For example, the current economic situation we are in is deflationary. So the most important thing to monitor is the total credit which actually determines the money supply. Another critical metric is property prices since in deflationary conditions, the endgame is always in real property. If the total credit and property prices are increasing, well and good. You can still dabble in stocks and commodities as they still have legs. Once the credit and property indicators start moving into negative territory, you'd better switch to US treasury bonds. Your goal is to preserve wealth, not to earn income. Actually from the vantage point of macroeconomics, that's a bad advice. Wealth should be destroyed so that we are motivated to create more wealth. But from the perspective of the individual layman, that's the advised approach.

So where to get the two indicators? The first can be extracted from the total credit report issued by the US Federal Reserve on a quarterly basis. The report is published with a two-month lag. For example, the measure for the last quarter of 2010 was issued on the 10th of March 2011. But the numbers are real numbers, not the estimates or surveys used in compiling the GDP or unemployment statistics. That's why the report always comes out late. Ben Bernanke would probably be the first person to peruse this report the moment it comes off the press.

Of the slew of files on the Fed's Statistical Release page, choose the 'Debt growth, borrowing and outstanding table'. The most important part of this document is on page 9, as reproduced below.
The aim here is to find out the extent of the annual change in credit computed on a quarterly basis. Extract the numbers from just three columns: the Total for Domestic nonfinancial sectors, the Domestic financial sectors and Foreign. Add the three and divide by the comparative figure for the same quarter last year. For example, the numbers for Q4 2010 (in US$ billions) are 36295.5, 14236.3 and 2104.4 which add up to 52636.2. The last number is the total credit in the US, i.e., $52.6 trillion. The equivalent total for Q4 2009 is 52260.9. Divide the 2010 number by that of 2009, you'll get a credit increase of only 0.7 percent in the last quarter of 2010. If you do the same for the preceding three quarters, you'll end up with marginally negative figures for all three.

The reason for this ambivalent state is obvious if you look at the Federal government column. It shows that since the last quarter of 2008, that is under President Bush's watch, the US federal government has been pumping more than a trillion dollars every single year, not to keep the economy growing but to prevent it from collapsing. Now as we enter 2011, this life support is being threatened by the debt limit and budget battle between the Democrats and the Republicans. Both parties do not understand that there is no solution; what has been carried out is only a countermeasure. The economy will collapse. Period. We can keep the economy on life support but the prolongation will make the eventual collapse worse. And if we take out the life support now as implored by the Tea Partiers, not only the US but the whole world will cave in.

The deficit or surplus debate is the mother of all Catch-22s, to paraphrase Saddam Hussein's famous remark. Rather than arguing who's right, it would have been better if the debate is framed between biting the bullet now and deferring it to the future but at a heavier price. Of course Obama wants to defer it to 2013 after he's secured his second term and the Republicans want it now so that they will see the last of Obama come 2012. Nobody cares about the jobless millions.

The other indicator is the housing price index. You can use the Case-Shiller 20-city or 10-city composite indices which are 3-month moving averages of housing prices. Like the Fed's total credit report, the published date is two months after, on the last Tuesday of every month. Select the seasonally adjusted Home Price Index Levels. Download it in Excel format so that you can easily carry out the needed computation.

If you look at the indices, whether the 10-city or 20-city, the peak was reached back in April 2006. Your objective is to compute the extent of the drop since then. For the 20-city, the index as of April 2006 was 206.55 while the latest for April 2011 was 141.62. The percentage fall is thus (206.55-141.62)/206.55 x 100 = 31.4 percent. The New York Times published a nice graph of the index since 1890 (see below) in January 2010. The chart taken from Shiller's Irrational Exuberance book was updated to reflect the latest housing prices then.
Three important points can be gleaned from this chart. First, it's the plotted projection. It shows an eventual fall of 50 percent. That's not Great Recession, mind you, but the Grand Depression in the works. Second, look at the period of the Great Depression in the early 1930s. The fall in nominal prices from 1925 to 1933 was only 30 percent but because of deflation the fall in real prices, bottoming in 1932, was only 13 percent. It was relatively mild simply because the borrowings were mainly used for speculation in the stock market. But the impact hit the man in the street real hard. What more when the man in the street is now indebted for his unpayable mortgage debt. Last, the curve follows the classic S-curve pattern, except that the pullback is going to be so severe, presaging the very hard times to come.

Alternatively, for a more encompassing home price index covering the whole of the US that reports data for the month only, you can rely on the real estate website, Like Case-Shiller, the index marks June 2006 as the zenith in the US home real estate prices with an average price of $241k. Up to March 2011, the price has continuously fallen a record 57 months. As of that month, the average price stood at $170k, a fall of a tad below 30 percent from its peak, not much different from that of Case-Shiller.

There you have it. Choose whatever index you want, they all tell the same picture, plain and clear. If you have investments in property and banks, it's time you bail out, that is, not the banks but you, your own self. Batten your hatch and brace yourself for the coming financial tsunami.

No comments:

Post a Comment