April 03, 2014

April 03, 2014

El Niño Weather Pattern Looks Likely in 2014Three national weather bureaus have issued warnings that 2014 may be an El Niño year, according to their climate models.  The emergence of this cyclical weather pattern this year could have significant implications for the prices of global commodities produced across a wide geographic area, including cocoa produced in Africa; rubber and palm oil produced in Southeast Asia; cattle produced in Australia; fish, fishmeal, and guano produced off the west coast of South America; and corn and soybeans produced in Brazil.   What are going to be the impacts on commodities?  What are the other risks?


China Eases — One More Step in the Dance

Chinese premier Li Keqiang gave a speech to provincial officials last week which indicated that the arrival of some form of stimulus to the Chinese economy is imminent.

We continue to hold our core China thesis, that a national financial crisis and a catastrophic growth slowdown are both fairly remote possibilities.  As we have outlined in this letter many times, we think that the Chinese government has the capacity to rein in the excesses of the shadow banking sector — gradually leveraging it down and leveraging up the official banking system.  And we think that those who are calling for a Chinese crash are uninformed about the nature of the Chinese financial system.

Premier Li Promises Growth Policies to Provincial Leaders
Premier Li.jpg

What are the policy implications?  What are the analysts predicting?

No Such Thing As Ex-KGB

The KGB is not a club, but a life-long commitment.  The lessons that were drummed into Vladimir Putin during his KGB training are not likely to be shifted, and recent Russian behavior confirms us in the view that today’s Russia is, in essence, a KGB state without the Communist Party to exercise power.  All dissent is treason, and the U.S. is the enemy — that seems to be the subtext of Mr Putin’s words and actions.  Realistic leaders in Europe and the U.S. will see that and draw appropriate policy conclusions for dealing with Russia in the future.

Lies, Damn Lies, and Statistics

We recently read an article by classicist, historian, and political scientist Victor Davis Hanson.  It expressed insights with which we agree, which we have often described in this letter, and are relevant to investors as they try to make sense of the macroeconomic landscape within which their investment decisions are being made.

Hanson notes simply that there is a crisis of confidence emerging in the U.S., related specifically to the role of what he describes as “our permanent meritocratic government bureaus that remain nonpartisan and honestly report the truth.”  That is, government agencies tasked with collecting and reporting scientific and economic data to the public in a nonpartisan way, whose methods and reporting are scrupulously impartial — executed according to scholarly and scientific accuracy, not according to the needs of some particular political agenda.

You can read Hanson’s comments here — http://victorhanson.com/wordpress/?p=7156.

The Relevance of Macro Indicators… and Their Questionable Trustworthiness

In our recent conference call, we noted that interest rates become problematic (among other reasons) if the rate at which they are rising exceeds the rate at which GDP is rising.  But in order to make a judgment about such an indicator, it’s vital that we have an accurate picture of the pace of U.S. GDP growth — is that rate increasing?  If so, how quickly?

Typically, we rely on the Bureau of Economic Analysis (BEA, part of the Department of Commerce) to give us answers to such questions.  That’s one of the “permanent meritocratic government bureaus” that Hanson notes as a necessary foundation for public trust — and with countless domestic and international economic actors relying on objective data from it, one can see why.

Unfortunately, however, it has become less simple to rely on the data provided by these ideally “impartial” government bodies.  In more and more cases, we have seen subtle changes in the way data are calculated and presented that leave doubt in our mind about how reliable they are.

Inflation and Unemployment, the Obvious Examples

Our readers will be familiar with our dissatisfaction with the government’s massaging of inflation data — a dissatisfaction which led us to construct our Guild Basic Needs Index™ (GBNI).  We believe that the GBNI offers investors and consumers a more “spin-free” view of the price levels of basic, essential items that real consumers face in the United States when they purchase their necessities.  For more on the GBNI, click here: www.gbni.info.

Guild Basic Needs Index

GBNI Feb2014.jpg
We have also believed that the government has a distinct interest in understating the level of inflation in the economy.  Over the years, adjustments in the official methodology have been made that relentlessly push in that direction.  We are not impugning the statisticians who compile and interpret these data — but we see a long-term trend, and it makes us question the official numbers enough to compile a data set of our own and compare it.

The Bureau of Labor Statistics generates consumer and producer price data; the bureau also generates the government’s employment data.  Governments have an obvious interest in understating unemployment as well as consumer price inflation.  Again, while we do not believe that there’s any chicanery going on in the BLS, we see that revisions to their methodology have consistently resulted in better-looking unemployment numbers. 

If, as investors, we want to know what’s really going on — if we want, for example, to reach a tactical decision about the health of the U.S. consumer to help us evaluate our approach to U.S. retail or to the housing market — now we need to add a grain of salt to the statistics we see from government agencies that are supposed to provide us with spin-free data.  We need to cast a wider net and consider other data points than the official ones.

Using Old Methodology

Sometimes all that’s necessary is to apply old methodology to current data.  That is, you take today’s numbers, and you calculate what inflation or unemployment would look like if you calculated them using methods that the BLS used to use 20 or 30 years ago. 

There’s an outfit that does just that (Shadow Government Statistics).  Below is their current CPI inflation chart, calculated using the methodology from 1980:

Unfortunately, even the key economic indicator, GDP, has not been immune from changes in methodology that have the (convenient?) side effect of producing results that are more flattering for the government that happens to be in power.

Last year, the BEA announced that moving forward, research and development expenditures would be included as an investment in the official calculation of GDP.  We don’t question the need for analysis to keep up with the economy, which has changed radically over the past several decades.  But we begin to worry when the new analytical methods produce a predictably rosier picture — lower inflation, lower unemployment, and higher economic growth.

Then we realize that to complement the official statistics, we need to go further afield.  It is critically important for us as investors to base our decisions on a knowledge of the real state of affairs that’s as close to objective as we can possibly get.  After all, people don’t eat, wear, or live in houses made of statistics.

The Crisis of Trust

If we discover that we can’t rely on public servants to do the same — to care first and foremost about the truth, the real facts, regardless of the political implications — then we have arrived at a real crisis of trust in our public institutions.  And our job as investors is that much harder, because we can’t take anything they say at face value.  Now, rather than being trustworthy sources of information, almost all economic indicators are simply starting points for our further investigation.

We may not like it, but it’s the world we live in.  We advise all investors to be, as we are, critical consumers of government data — always looking for further data points to confirm or refute what government statisticians tell us.

Europe Edges Closer to QE

The president of Germany’s national Bundesbank came out last week with an understated but dramatic reversal of his previous opposition to quantitative easing (QE).  Jens Weidmann now says that it is not “out of the question” for the European Central Bank (ECB) to buy sovereign bonds of Eurozone governments.

This means that ECB president Mario Draghi now no longer faces the outright resistance of the Eurozone’s strongest economy.  This comes as new data points show Europe as a whole tipping dangerously close to deflation (with Spain posting price declines).  Analysts have been talking about the risk of Europe entering a long-term Japanese-style deflationary or disinflationary trap.  Various commentators, including the head of the Finnish central bank, again brought up the possibility of negative interest rates and other unconventional measures by the ECB.

Europe has managed so far to muddle out of the Great Recession fairly well, given that, unlike the U.S. and Japan, its central bank has not embarked on QE or other unorthodox policies.  It’s unlikely that QE will be immediately forthcoming, but if it is, it will be bullish for European exporters and financials.

On a broader level, we’ve heard German finance minister Wolfgang Schäuble suggesting changes to EU governance after May’s elections that would centralize fiscal governance in the bloc.  He envisions a central budget office with the power to reject national budgets and with access to common funds.  However, given the recent advances of populist nationalism in Europe — such as the recent strong showing of France’s National Front — such plans may meet stiff resistance from European voters.

What does this mean for Euroezone?  Upgrade your subscription today to find out.




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Market Summary

We discuss Europe, the United States economy, emerging markets and Japan, and commodities.


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  • Yuan “Carry Trade” Hits a Snag
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