my friday five

Happy Halloween!  Today is the day to indulge in fabulous sweets and treats and  I could not help but notice how enticing these Browned Butter Pumpkin Cupcakes are!  And, I know they will be delicious because Coco cooks the most fabulous food.  You can find her recipe here.  PS the frosting is brown butter fudge!

I just found out that one of my photos will be used on a mood board for a fabulous tv show in the UK called The Great Interior Design Challenge.  The show is scheduled to air on November 20^th in the UK, but I am hoping to get a peek from their website.  Kind of random, but fun news! 

My new favorite treat is Foxy’s Frozen Yogurt’s “Frisky” flavor aka Pecan and Praline Crunch.  It’s so yummy and not so bad in the calorie department, only 120 calories.  They also make Cheeky, Sneaky, Naughty, Sassy and Fancy flavors.  Which one do you want to try? It’s available at Gelson’s, Fresh and Easy Markets and other gourmet shops.  I love their fun retro vibe too!

This has got to be everyone’s favorite Halloween special, "It's the Great Pumpkin Charlie Brown". Here are 9 favorite quotes from our dear Peanuts characters.

 Happy Halloween!

ciao! Fabiana

Litmus/Glass Love/Last Hope

Still have copies of the Kidman oeuvre for those who foolishly haven't got them, or those who have worn theirs out. Litmus & Glass Love, single disc versions $15 each, Last Hope $25. As good as surf movies get. Email info @ foamandfunction.com to order or inquire or whatever.

Japan shakes things up

Back in early January of last year I had a post titled "The biggest news is the weaker yen." Japan had shocked the world with news that it was finally getting serious about stimulating its economy. Perhaps most important was the news that the BoJ wanted to reverse the decades-long, relentless strengthening of the yen. The perpetually strong and stronger yen was the source of Japan's deflationary slump (even though there wasn't much actual deflation). A continually rising yen was strangling Japan's manufacturers and exporters, since they were continually forced to lower their prices to compete with overseas rivals. A weaker, more reasonably-priced and more-stable yen would be a significant first step to reinvigorating Japan's economy.

Today the yen dropped significantly, returning to levels last seen about seven years ago, on news that the BoJ was redoubling its efforts to provide monetary stimulation by aggressively expanding the monetary base. The stock market responded by also jumping to levels last seen seven years ago. The tight, inverse correlation between the value of the yen and the value of the stock market confirms that the strong yen was a big problem for the Japanese economy.

According to my calculations, the yen is now back to levels that are very close to what I consider "Purchasing Power Parity" with the dollar. It's reasonably priced. It's not weak, and it's not strong. It's now a neutral, rather than a negative factor for the economy. The future of the Japanese economy looks brighter. What will really make a difference, however, is a decision by the Japanese government to also adopt genuine fiscally-stimulative measures such as lower marginal tax rates, reduced government spending, and reduced regulatory burdens.

In the meantime, the world was also shocked this morning to learn that the investment guidelines of Japan's (and the world's) biggest pension fund, which currently holds most of its $1.3 trillion in assets in very low-yielding bonds. At least half of this sum will be departing bond land in the direction of equity land, and that is a pretty aggressive move. It's a solid chunk of evidence that the world is becoming less risk averse. That's the broader and most important trend to be found in economies and stock markets around the world these days.

$2 trillion GDP shortfall

Third quarter real GDP grew somewhat faster than expected (3.5% vs. 3.0%), and on top of the 2nd quarter's 4.6%, that gives us annualized growth of just over 4%. Wow: has economic growth really ramped up than much? I'd like to think things have improved a bit of late, but in any event it's premature to reach that conclusion—we'll need to see at least another quarter's worth of stronger growth to be sure.

Abstracting from the quarterly numbers, which are always volatile, real GDP growth over the past two years has been 2.3% annualized (see chart above). It's also been 2.3% annualized since the recovery began in mid 2009. This has been a 2.3% growth rate recovery for over 5 years. Nothing much has changed, at least so far.

As the chart above shows, this has been the weakest recovery in history. The economy is now about 10% below its long-term trend growth potential. In other words, nominal GDP today would have to be $2 trillion higher to get us back on the economy's long-term trend. Due to a variety of factors (e.g., too much income redistribution, high marginal tax rates, too many additions to regulatory burdens, Obamacare, geopolitical uncertainty, unusually strong and persistent risk aversion, the retirement of the baby boomers), we are missing out on $2 trillion of annual income and 10 million or so jobs.

This is a big deal, and this is why the electorate is upset. We've made some terrible decisions and left an awful lot of money on the table.

But I do think it's likely that the economy is gaining strength on the margin. One reason for that is the big decline in government spending relative to GDP, which has dropped from a high of 24.4% to 20.3% in the past five years (see chart above), mainly because spending has not increased at all during this recovery. Spending is taxation, so what we've seen in the past five years is a huge decline in expected tax burdens. A considerable amount of weight has been lifted from taxpayers' shoulders. The private sector now has more breathing room. The private sector is now spending a larger share of its own money, and that means that spending in aggregate will be smarter, more efficient, and more productive. (Keynesians, by the way, get this all wrong: they think the economy has suffered because the government has not spent more and because the deficit has declined—that fiscal austerity is the culprit behind weak growth.)

Meanwhile, it seems increasingly likely that the electorate next week will repudiate the current administration's policies. At the very least we are likely to see congressional gridlock, which could keep spending from growing and reduce the burden of government further. More likely, we'll seen Congress make progress on reducing our onerous corporate tax rate, which could result in more new investment and more new jobs. We might even see some much-needed reform of our absurdly distorted tax code, and some sensible, market-based reforms to healthcare.

You can already feel the policy winds shifting. Instead of headwinds, we are starting to get tailwinds. This is very good news. There is a lot of ground to make up, and a lot of upside potential if we get things right in the next few years. It pays to remain optimistic.

QE3 R.I.P.

Today the Federal Reserve confirmed what the bond market has been expecting for many months: QE3 has ended, effective this week. What we don't know yet, however, is whether the end of QE3 will lead to another round of economic and financial market distress like we saw after the end of QE1 and QE2. I think we'll be OK this time around, because several key indicators today look a lot healthier than they did when QE1 and QE2 ended.

But first, let me point out once again that the real purpose of QE was not to print money or stimulate growth. It was to "transmogrify" notes and bonds into T-bill substitutes (aka bank reserves). QE boils down to the Fed simply swapping bank reserves for notes and bonds. Banks have been happy to hold most of the extra reserves as "excess" reserves, which means that they didn't use their reserves to collateralize a huge increase in lending. There was a huge demand for reserves qua reserves, and QE simply satisfied that demand. Without QE there would have been a critical shortage of safe, risk-free assets, and that would have threatened financial stability.

This time around, it looks like the demand for safe assets like bank reserves has declined and there's more financial stability, which means there is no longer a need for QE. Here's a quick look at the evidence:

The chart above shows the history of QE and 10-yr Treasury yields. Most of the Fed's quantitative easing efforts were focused on longer-term Treasuries, in a professed attempt to artificially depress yields and thus stimulate lending and the economy. But as the chart demonstrates, 10-yr yields rose over the course of each episode of QE. Moreover, 10-yr yields were unchanged during the period of Operation Twist, in spite of the fact that OT placed extra emphasis on bringing down 10-yr yields by buying long bonds and selling short bonds. In short, QE never achieved its intended result. I think that's because monetary policy is incapable of artificially manipulating long-term Treasury yields. Those yields are not determined by the size of Fed bond purchases, but rather by the bond market's perception of underlying economic and inflation fundamentals. Yields rose despite QE purchases because QE addressed a fundamental problem—a shortage of risk-free assets—and thus QE improved the outlook for growth.

It may sound strange, but despite the Fed's massive purchases of notes and bonds (totaling over $3 trillion), the Fed today holds about the same percentage of outstanding Treasuries as it did 10 years ago (see chart above). To be fair, a good portion of the Fed's holdings of Treasuries prior to the Great Recession were T-bills (a little over 30%). The Fed sold almost all of its T-bills in the first half of 2008 as it tried to respond to the market's desperate desire for risk-free assets. But it wasn't enough, and that is one of the reasons the Fed decided to embark on QE1.

In any event, after all those purchases of notes and bonds, 10-yr yields today are right around the same level as they were when QE1 was first launched. As the chart also shows, the correlation between big changes in the Fed's bond holdings and the level of 10-yr yields is not what we were told to expect. Big increases in Fed bond purchases (i.e., periods in which the blue line rose) were supposed to produce big declines in yields, because lots of Fed bond buying would push bond prices up. More often than not, however, the reverse occurred (i.e., both the red and blue lines moved together).

The chart above compares the S&P 500 index to the Euro Stoxx index. Both suffered serious corrections following the (largely unexpected) end of QE1 and QE2. The market is understandably concerned that this might happen again, now that QE3 has ended. Note, however, that equity valuations are significantly better today than they were at the end of QE1 and QE2, even though the end of QE3 has been known with reasonable certainty for many months. QE1 and QE2 were never tapered, by the way, they just ended all of a sudden. In contrast, the Fed has been tapering QE3 for the past 10 months. The end of QE3 cannot be a surprise or a disappointment to anyone at this point. If anything, it's a relief to know that it's over.

 
The chart above compares the level of 2-yr swap spreads—excellent coincident and leading indicators of systemic risk and economic and financial market health (see longer explanation here)—in both the U.S. and the Eurozone. Note that swap spreads rose significantly in advance of the recession and declined significantly in advance of the beginning of recovery. Note that they also rose following the end of QE1 and QE2. The major source of risk in the past four years has been the Eurozone, which has struggled with sovereign default risk and a double-dip recession. Eurozone banks were desperate to shore up their balance sheets throughout, thus creating significant demand for risk-free assets. Eurozone swap spreads were already elevated—symptomatic of rising systemic risk—in the runup to both QE1 and QE2, and they widened further after they ended. U.S. swap spreads rose in sympathy with Eurozone spreads, but to a lesser degree and starting from a lower base. Today, swap spreads in both regions are comfortably within "normal" territory. This, along with higher equity prices, suggests that the end of QE3 will not be painful.

The chart above compares the price of gold to the price of 5-yr TIPS, using the inverse of their real yield as a proxy for their price. Both of these are unique types of risk-free assets. Gold, because it is a classic refuge from political and monetary risk, and TIPS, because they are protected against inflation, they pay a government guaranteed real yield, and they are relatively short-term in nature. As the chart shows, the prices of both of these risk-free assets have been declining for the past few years. In other words, the market's demand for risk-free assets is lower (and falling on the margin) than it was when QE1 and QE2 were terminated. Again, this suggests that the end of QE3 should not result in tears. The market is no longer in need of more risk-free securities.

QE3, R.I.P.

same house, two different Fall looks

This is an iconic house here in the neighborhood.  It stands out on it’s own as a beautifully designed home, but during the holidays, it really comes to life!  I took photo number one for my blog a few years ago and photo number two is in a recent issue of Better Homes and Gardens magazine .    

It’s fun to see the evolution of this home, inside and out.  Home owner Jeanne Carmack has amazing style and eye-catching ideas, like these straw wreaths used indoors and outdoors for a gorgeous Autumn display.  Check out her home’s own pinterest board here.      

ciao! Fabiana

Climbing the latest wall of worry

As I mentioned about three weeks ago, stocks have been climbing walls of worry throughout the recovery which began some 5 ½ years ago. Almost every selloff in the past two years has been accompanied by/caused by an emotional response to new or recurring sources of uncertainty and fear. The latest wall of worry was built on a foundation of concern for the health of the Eurozone, the Chinese economy, and the spread of Ebola.

But as long as the economy avoids a recession, it is hard to keep stock prices down, especially when cash yields almost nothing and earnings are robust. If the fears aren't realized, emotions drop and prices pop back up.

Nothing says it better than the chart above. The ratio of the Vix index (a proxy for the cost of options that reduce one's equity risk) to the 10-yr Treasury yield (a proxy for the market's confidence in the health of the economy) spiked at precisely the time the equity market hit its recent lows. Since then, the Ebola crisis seems less likely to spiral out of control, the Eurozone appears to be stabilizing, and we continue to get positive readings on key economic stats here. Here are some of the latest signs of strength and expansion:

I don't usually pay much attention to the regional Fed economic activity indices, but today's release of the Richmond Fed's Manufacturing Index piqued my interest. It's normally quite volatile—which is why it should be taken with a few grains of salt—but the latest reading was the third strongest in the current business cycle expansion, and over the past 20 years it has only rarely been this strong. Something good must be going on in the Richmond area.

September capital goods orders were down a bit, but this series too is quite volatile. On a year over year basis, orders are up a solid 7.6%. Using a rolling 3-mo. average, the index is up at an annualized pace of 11% over the past six months. By just about any measure, this proxy for business investment looks healthy and strong. It hasn't yet exceeded its prior high in inflation-adjusted terms, and that's disappointing, but then again we know that the current expansion has been sub-par, and weighted down by pervasive risk aversion. The important thing to focus on is the change on the margin, and that is undeniably positive. The broader durable goods orders (ex-transportation) is up at a 6.4% annualized pace over the past six months.

The Markit survey of Eurozone manufacturing conditions in October ticked up a bit, suggesting that at the very least the region is not headed down a black hole. The Eurozone is seriously lagging the U.S. economy, but it is not collapsing.

Falling energy prices are virtually certain to make a positive contribution to growth both here and abroad. Crude oil is down almost 30% from its 2011 high, and gasoline prices at the pump (see chart above) are down by 25%. Pump prices will likely keep falling to at least $2.90/gal., according to the current price of gasoline futures. It takes energy to run an economy (consumers spend about 6% of their total consumption expenditures on energy), so when energy becomes cheaper the GDP pie tends to grow since money is freed up for other things.

UPDATE: (Oct. 31st am) The stock market has now reached a new high, completely recovering from the recent panic-driven selloff. Interestingly, the Vix/10-yr ratio is still somewhat elevated. People are still nervous about what's going on, and the 10-yr yield remains quite low, a sign that investors don't believe that Japan's surprise stimulus measures announced early today will do much to jolt the U.S. economy out of its weak-growth doldrums.

How I see things

A quick recap of how I see the current state of markets and the economy:

Inflation: Contrary to the expectations of many monetarists, including myself, inflation remains subdued. This can only mean that monetary policy has not, contrary to what most believe, been "stimulative." Inflation happens when the supply of money exceeds the demand for it; that we haven't seen higher inflation is proof that the Fed has not been printing money, as I've long argued. Quantitative Easing has been all about swapping bank reserves (T-bill substitutes) for notes and bonds. Demand for safe assets like T-bills and short-term notes has been intense, and the Fed has effectively accommodated the market's demand for safe assets. It's been a very risk-averse recovery, and had the Fed not engaged in QE, there would have been a severe shortage of the things the market has most wanted.

Growth: It's been a sub-par recovery, despite massive fiscal "stimulus." Actually, it's more correct to say that it's been a sub-par recovery because of too much government spending. Government spending, which has been dominated by transfer payments, wastes money and creates perverse incentives. It's also been a sub-par recovery because the world has been so risk-averse. Corporate profits have been abundant, but businesses have been reluctant to invest those profits due to persistent risk aversion. The U.S. economy has grown mainly because of its inherent dynamism and ability to overcome adversity, and because most people here naturally want to improve their lot in life by working harder, saving, investing, and taking risk.

The dollar: Until recently, the dollar has been very weak against virtually all currencies. This was the by-product of 1) the Fed's QE policy (which many thought would severely debase the dollar), 2) the government's massive deficit-financed spending (which increased expected tax burdens, thus depressing investment and growth), and 3) the huge increase in regulatory burdens (think Obamacare and Dodd-Frank) which have also depressed growth and investment. The dollar has improved of late because 1) the economy has done better than dismal expectations, 2) the U.S. economy is outperforming the Eurozone economy, and 3) the policy outlook is improving as elections approach and the Obama administration's agenda (which consists of a relentless effort to expand government's power and influence over the economy, which in turn dims the prospects for healthy growth) shrinks to near-nothingness.

Interest rates: It should now be abundantly clear that QE was not about lowering interest rates, and low interest rates do not stimulate growth. Interest rates have actually risen during each episode of QE. Monetary policy cannot fine-tune economic growth, and it cannot create growth out of thin air. Low interest rates may be good for borrowers, but not for lenders; in a sense, the Fed's attempts to manipulate interest rates proved to be a zero-sum game (at best). Today's low interest rates are symptomatic of the persistence of risk aversion: zero interest rates on high-quality risk-free securities reflect intense demand for those securities and that safety. In a booming economy, cash is a drag; in today's economy, cash is a refuge from uncertainty.

Equities: The stock market is not artificially inflated. Prices are up because the economy has consistently exceeded expectations, and because corporate profits are at near-record levels, both nominally and relative to GDP. The current level of PE ratios is only modestly higher than their long-term average. The earnings yield on stocks compares very favorably to the yield on corporate bonds, which is again symptomatic of a market that is risk averse.

Gold: Gold prices are still quite elevated relative to their long-term inflation-adjusted average, which I calculate to be roughly $600/oz. Gold rose because investors feared a host of potential calamities: a global financial collapse, a Middle East meltdown, and a QE-fueled explosion of inflation. Gold has fallen in recent years because those fears have been largely unrealized. Gold is still very expensive, however, because investors are still very risk averse, only somewhat less so than a few years ago. Commodity prices have tended to follow gold prices, but they are not as overextended as gold prices today.

The future: There are abundant signs that the U.S. economy continues to grow, albeit relatively slowly. This is likely to continue, and it is possible that growth could improve somewhat in the foreseeable future because: 1) government spending as a % of GDP has shrunk dramatically, thus reducing the drag of spending on growth, and 2) the policy outlook should improve in the wake of next week's elections, as policy is likely to become more business- and growth-friendly.

The Fed: Members of the FOMC are overly-impressed with their ability to "guide" the U.S. economy, and overly-concerned with the relatively low level of current inflation. Monetary policy was never meant to be an instrument for fine-tuning growth, much less creating or promoting growth. Monetary policy that is good and proper can facilitate growth, but it cannot create growth. Growth comes only from working harder, investing, and taking risk, and low interest rates do nothing in that regard. Massive changes in the way monetary policy is conducted only create uncertainty which depresses investment and growth. One key source of risk going forward is that, because of the Fed's hubris, FOMC members may fail to react in a timely fashion to signs of improving confidence and declining money demand: a failure to reverse QE in response to a decline in the demand for safe assets could result in an unwelcome abundance of money and higher inflation. At today's levels, Treasury yields offer hardly any cushion at all for this risk and are thus very unattractive. Deflation, contrary to widespread claims in the punditocracy, is not a threat to growth, and is not a black hole that captures and annihilates slow-growing economies.

All of these themes have appeared in my posts over the past 5-6 years. If anything has changed of late, it is that risk aversion appears to be on a slow decline, and the outlook for fiscal policy is improving, if only because the misguided policies of the past 5-6 years have failed so miserably. One long-enduring theme has been that the equities were likely to do well because the economy was likely to exceed expectations, which were dismal because of all the risk aversion, fears, and uncertainties that have existed.

The world doesn't change on a dime, and so many of these same themes are likely to survive for another few years at least.

Putting your search coil over gold

Yesterday morning I went to a popular tourist beach to search for gold jewelry, surprisingly I had the beach to myself. 

I never saw one other person metal detecting on this busy south Florida beach,  and then it dawned on me why I had not seen other people metal detecting.  

It was approaching high tide, maybe if I had waited around until two hours before low tide I would have seen other people metal detecting on Sunday. 

It still amazes me how much gold jewelry I still recover on heavily hunted beaches, I guess I am lucky the local beach and water hunters do not read this blog lol! 

The beach I visited for three hours early on Sunday morning, usually has more water hunters than beach hunters. 

Even though it is a busy beach, most people metal detecting are either water hunting with the navy seal look in deep water, or beach hunting by walking a straight line in the wet sand and running to the next beach to walk in another straight line. 

The water was sanded in, but I have always found plenty of gold in the wet and dry sand, so that is where I began my search for more gold. 

This is one of the good things about being a versatile beach hunter, not being a one trick pony blindly searching the same way every time. 

I decided to search the place on this beach that other beach and water hunters walk away from, the busy beach entrance. 

It was very early in the morning, the perfect time to search the beach entrance without getting bombarded with "What are you looking for?" questions.  

The 14K wedding band was recovered close to the water, trying to beat the full high tide to the area. 

The 10K ring with small diamond chips was recovered along the high tide line, the 18K band was recovered mid beach up in the dry sand. 

Three gold rings from three different areas of the beach,  no silver jewelry and not a lot of junk, but stacks of clad coins. 

It was great to be out with a metal detector in my hand for the first time this month, and still good to see the glint of gold as the Florida sun rises. 

If you want to put your search coil over gold,  check out your local beach and water hunting competition, you may be surprised just how little of the beach they really cover. 

Avoid being a slave to the low tide, avoid only searching one area of the beach, becoming a versatile beach hunter is the key to putting your search coil over gold. 

 

favorite October mantels

There are only a few days left to enjoy what's left of October, and I wanted to share with you some  fun mantel décor that caught my eye this week.    This first one is playful, yet elegant too.  A few simple black paper bats add height and charm to this traditional white mantelpiece.  Add to it some black and white accessories to complete the look.  

A variety of pumpkins and pine cones set 

the mood in this French Country Cottage .

Spooky artwork and black ivy accent the "Boo" lettering. 

 Black cheesecloth, bare branches and vintage touches 

add mystery to this otherwise all white backdrop. 

Isn't the masquerade mask a fun accent? 

Mid-century style with just a touch of orange. 

Brown paper flowers remind us of Autumn 

and are so pretty in this neutral vignette.

Why not create your own display using natural elements like 

gourds and branches that will last right through Thanksgiving?

ciao! fabiana

Claims collapse

On a four-week moving average basis, weekly initial claims for unemployment in April 2000 were a few thousand lower than they were last week (top chart), but compared to the size of the workforce, they have never been lower than they were last week (second chart). 

The only potentially disturbing thing about this is that recessions tend to follow lows in unemployment claims. Maybe, if things can't get much better, they are likely to get worse? I think that's a premature concern, if not an meaningless concern. Low levels of firings don't cause recessions. Low levels of firings usually happen when the economy is humming along and inflation is increasing. That—rising inflation and strong growth—is what prompts the Fed to tighten monetary policy, and tighter policy inevitably results in the economy sliding into a recession a year or so later. The current recovery stands in sharp contrast: it's the weakest on record, the Fed has never been more accommodative, and the Fed is probably years away from tightening policy by enough to strangle the economy.

Plus, one of the reasons this is a weak recovery is that the pace of hiring has been relatively tepid. If this were a normal economy we might have as many as 10 million additional jobs by now. Businesses have yet to become euphoric and over-build and over-hire. Businesses instead have been very cautious this time around, keeping their operations lean and mean and their bottom lines strong. This increases the odds that the current recovery still has years of life left. Recessions usually follow periods of over-confidence; confidence today is still relatively low, and caution is still prevalent.

With firings at very low levels, it's not surprising to see that the number of persons collecting unemployment insurance hasn't been as low as it is today for the past 14 years. In less than a year the number has dropped by more than half, from 4.65 million at the end of last year to only 2 million last week. From the all-time peak of 2010, almost 10 million people have dropped off the unemployment claims rolls in just five years.

Those are dramatic changes, especially in an era which transfer payments (unemployment insurance, welfare, food stamps, disability, medicare, social security, etc.) have risen to a new all-time nominal high ($2.5 trillion)) and a new all-time high relative to total federal spending (72%). Never have so few received government assistance for losing their job, and never have so many received so much for not working.

It's not just the weakest recovery, it's the craziest.

host the perfect Halloween dinner party

a great menu is a must! 

make sure you have a signature cocktail

and a pretty table setting with  place cards

make the appetizers and food fun!

create an interesting backdrop 

an inverted fish bowl can add drama

wouldn't you love to enter a party like this?

the more candles the better!

a little glitter never hurt anyone... 

and how about a unique costume?  

For photo sources, visit Halloween Dinner.

ciao! Fabiana