I am writing this in the second-class cabin of the Wales to London express train, which is packed to the gills with holiday revelers. In the adjacent seat there is a gaggle of four young ladies dressed to the, nines sporting feathers from their hats, obviously headed for a late summer wedding. They are sharing a bottle of Cava, or cheap Spanish Champagne, and the spirited conversation is increasing in volume with each passing mile. As it is all in Welsh I can’t understand a word.
Nevertheless, I shall attempt to impart to you some market insights, even in these most trying of conditions.
There is a major contradiction going on in the US economy these days. The government data releases speak of a feeble rate of business expansion that is puttering along at only 2% rate. But speak to the CEO’s of major companies and they talk of growth, expansion, and increased capital investment with a guarded optimism that lines up with a more robust 4% GDP growth rate. This is going on not just into the US, but in Europe, Asia, and Australia as well.
Who’s got it right, the government, or the CEO’s?
One of the most valuable lessons I learned as a journalist many decades ago is that you always follow the companies. Speak to management, and they will magically reveal trends that won’t show up in the public data releases for months, or even years. And capital always follows the companies, as JP Morgan head of investment, Carl Van Horne, once told me.
That is one of the many reasons you read this letter, to discover economy trends before the rest of the world does. And what is the collective wisdom of the planet’s CEO’s? That things are a lot better than they appear. Who has already figured this out? The stock market. This is why the S& P earnings multiple has expanded by tree points this year, from 12.5X to 15.5X, or some 25%. This is also why this has been the most hated stock market rally in history.
I have always been a strong believer in the wisdom of crowds, that markets see events and their implications well before single individuals can. A good example is the 1942 Battle of Midway, where Japan lost four aircraft carriers, thanks to a masterstroke of American intelligence. Look at your 100-year stock charts, and you will see this, to the day, marked the beginning of a bull market that lasted until the early 1970’s, even though the actual outcome of the battle was kept top secret for years.
However, I think there is much more going on here than human mass psychology. When guests ask at my lectures and luncheons about the accuracy of government data coming out of China, I shoot back “What about our data?” The entire field of government statistics is greatly flawed, no matter who is issuing it.
As a former scientist, I was horrified when I first saw such large bets placed by investors on such weak information. As my college math professor used to say, “Statistics are like a bikini. What they reveal is fascinating, but what they conceal is essential.”
The very nature of government information collecting guarantees that it is riddled with flaws. The US is a massive country, with reporting entities often reaching the tens of thousands. The time frame over which of these collects data can vary, leading to wonderful apple an orange comparisons. Surveys are the worst, easily falling victim to the natural human tendency to tell people what they want to hear. Often, they say the opposite of what they believe.
Then there is the GDP. The pattern that has emerged over recent years has been for a number to start out strong, and then get revised down substantially in the following quarters. Or visa versa. The monthly nonfarm payrolls are even worse.
This is why PIMCO boss, Bill Gross, says that the weekly jobless claims are the one statistical update he’d welcome if stranded on a desert island. A least the mistakes are flushed out every week, rather than monthly or quarterly. For what its worth, that number is at 330,000, a five year low, predicting further share price gains.
The Treasury’s Bureau of Economic Analysis has recently tried to bring the GDP numbers closer to reality by redefining the term. It finally changed “research and investment” from an expense to an investment to be depreciated over many years, which it really is.
It also created a new category for “intellectual property”. What are the reruns of “Bewitched”, “Bonanza,” and “Gilligan’s Island” worth? Before, it was nothing. Now it is something. This has enormous implications for technology companies and content creators of every stripe, including myself. That Hedge Fund Radio interview I did with Barton Biggs four years ago is still generating mouse clicks, and therefore revenues, even though he sadly passed away last year. Barton would be proud.
All told, the changes added $560 billion to US GDP, taking the total up 3.6% to $16.6 trillion. That is the equivalent to adding another State of New Jersey to our economy out of thin air. Of course, the right cried foul, as it always does, deriding the attempt to make the country look better than it actually is. In reality, the government data is still miles away from reflecting a true picture of the economy. So what changes are coming next is anyone’s guess.
I’ll ask Treasury Secretary, Jack Lew, when I meet him in person on Thursday.
Well, the ladies next door are fairly plastered now, having moved up from Champagne to blueberry Vodka. One girl is clearly wearing more of her drink than she has imbibed. They have even offered the kindly, white haired old man with the beard in the next seat a glass. I will, no doubt, regale them with great wisdom on the pleasures and pitfalls of married life.
So that’s it for now.
