Category: Economy

Will AI Allow for Better Service, Higher Profit?

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Image Credit: KAZ Vorpal (Flickr)

Will AI Learn to Become a Better Entrepreneur than You?

Contemporary businesses use artificial intelligence (AI) tools to assist with operations and compete in the marketplace. AI enables firms and entrepreneurs to make data-driven decisions and to quicken the data-gathering process. When creating strategy, buying, selling, and increasing marketplace discovery, firms need to ask: What is better, artificial or human intelligence?

A recent article from the Harvard Business Review, “Can AI Help You Sell?,” stated, “Better algorithms lead to better service and greater success.” The attributes of the successful entrepreneur, such as calculated risk taking, dealing with uncertainty, keen sense for market signals, and adjusting to marketplace changes might be a thing of the past. Can AI take the place of the human entrepreneur? Would sophisticated artificial intelligence be able to spot market prices better, adjust to expectations better, and steer production toward the needs of consumers better than a human?

In one of my classes this semester, students and I discussed the role of AI, deep machine learning, and natural language processing (NLP) in driving many of the decisions and operations a human would otherwise provide within the firm. Of course, half of the class felt that the integration of some level of AI into many firms’ operations and resource management is beneficial in creating a competitive advantage.

However, the other half felt using AI will inevitably disable humans’ function in the market economy, resulting in less and less individualism. In other words, the firm will be overrun by AI. We can see that even younger college students are on the fence about whether AI will eliminate humans’ function in the market economy. We concluded as a class that AI and machine learning have their promises and shortcomings.

After class, I started thinking about the digital world of entrepreneurship. E-commerce demands the use of AI to reach customers, sell goods, produce goods, and host exchange—in conjunction with a human entrepreneur, of course.

However, AI—machine learning or deep machine learning—could also be tasked with creating a business-based model, examining the data on customers’ needs, designing a web page, and creating ads. Could AI adjust to market action and react to market uncertainty like a human? The answer may be a resounding yes! So, could AI eliminate the human entrepreneur?

Algorithm-XLab explains deep machine learning as something that “allows computers to solve complex problems. These systems can even handle diverse masses of unstructured data set.” Algorithm-XLab compared deep learning with human learning favorably, stating, “While a human can easily lose concentration, and possibly make a mistake, a robot won’t.”

This statement by Algorithm-XLab challenges the idea that trial and error leads to greater market knowledge and better enables entrepreneurs to provide consumers with what they are willing to buy. The statement also portrays the marketplace as a process where people have perfect knowledge and an equilibrium point, and it implies that humans do not have specialized knowledge of time and place.

The use of AI and its tools of deep learning and language processing do have their benefits from a technical standpoint. AI can determine how to produce hula hoops better, but can it determine whether to produce them or devote energy elsewhere? If entrepreneurs discover market opportunities, they must weigh the advantages and disadvantages of their potential actions. Will AI have the same entrepreneurial foresight?

The acquisition of market knowledge can take humans years to acquire; AI is much faster at it than humans would be. For example, the Allen Institute for AI is “working on systems that can take science tests, which require a knowledge of unstated facts and common sense that humans develop over the course of their lives.” The ability to process unstated, scattered facts is precisely the kind of characteristic we attribute to entrepreneurs. Processes, changes, and choices characterize the operation of the market, and the entrepreneur is at the center of this market function.

There is no doubt that contemporary firms use deep learning for strategy, operations, logistics, sales, and record keeping for human resources (HR) decision-making, according to a Bain & Company article titled “HR’s New Digital Mandate.” While focused on HR, the digital mandate does lend itself to questioning the use of entrepreneurial thinking and strategy conducted within a firm. After AI has learned how to operate a firm using robotic process automation and NLP capacities to their maximum, might it outstrip the human natural entrepreneurial abilities?

AI is used in everyday life, such as self-checkout at the grocery store, online shopping, social media interaction, dating apps, and virtual doctor appointments. Product delivery, financing, and development services increasingly involve an AI-as-a-service component. AI as a service minimizes the costs of gathering and processing customer insights, something usually associated with a team of human minds projecting key performance indicators aligned with an organizational strategy.

The human entrepreneur has a competitive advantage insofar as handling ambiguous customer feedback and in effect creating an entrepreneurial response and delivering satisfaction. We seek to determine whether AI has replaced human energy in some areas of life. Can AI understand human uneasiness or dissatisfaction, or the subjectivity of value felt by the consumer? AI can produce hula hoops, but can it articulate plans and gather the resources needed to produce them in the first place?.

In what, if any, entrepreneurial functions can AI outperform the human entrepreneur? The human entrepreneur is willing to take risks, adjust to the needs of consumers, pick up price signals, and understand customer choices. Could the human entrepreneur soon become an extinct class? If so, would machine learning and natural processing AI understand the differences between free and highly regulated markets? If so, which would it prefer, or which would it create?

The One -Two Punch that Caught Gold Off-Guard

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Image Credit: RaymondClarkeImages (Flickr)

Gold Softens as Yields Rise on US Treasuries From Inflation Stickiness

As the month of February began, the talk was for gold to hit $2,000 an ounce in the first quarter. But, as is often the case with investment markets, once certainty creeps into the mindset, something unexpected often comes along and undermines it. Gold may very well reach the $2,000 price in early 2023, but it has, for now, taken a small hit caused by a resurgence of expectations related to inflation’s pervasiveness. The inflation itself isn’t necessarily a problem, it is the chain reaction of events that then follows.

The One Two-Punch Catches Gold Off-Guard

Gold futures reached 10-month highs near $1,975 just before the release of January U.S. non-farm payrolls were reported on February 3rd. The Friday release showed large gains in the employment condition which stoked old inflation worries.

Concerns about inflation had been settling down before the jobs number. One indication of that is US bond yields had been priced, by most measures, for an eventual easing of rates, not tightening of conditions. The employment report itself began to unwind gold’s strength. The price sank to below $1,830 before recovering to around $1,875. The reason is that higher inflation, begets higher expectations of bond yields, which then begets capital flows into dollars to take advantage of the higher rates available. Gold becomes relatively weaker and less desirable under these conditions.

On February 14th, as some AU investors were falling out of love with gold, an inflation report (CPI) for January showed a tick-up in January prices over December’s numbers. This exacerbated U.S. inflation fears and helped to bring gold back under $1,850.

New Expectations

The shift in expectations over a two week period are not likely to unwind without new information which undermines the new employment and inflation reports. That doesn’t seem likely in the coming days as a just released wholesale price report (PPI) now indicates inflation is more than a services sector concern.

Gold long positions are now caught in the crosshairs of the Fed’s resolve to fight inflation. Every treasury yield spike has led to a dollar spike and been used as an opportunity to reduce demand for gold or reduce it’s relative value against US dollars.

Source: Koyfin

Historically, gold prices had risen with inflation as investors bought the currency alternative as a hedge against paper currency. Currency typically loses value when prices go up. What happened then is more typical and is what is still taught in textbooks – good economic news was good for risk assets.

More recently, good economic news, worries investors because it has the potential to make inflation hotter, prompting the Fed to dial up rates and hurt everything from stocks to gold and oil. The positive correlation is on hiatus, probably until the Fed’s finger comes off the rates trigger.

Take Away

The markets had begun looking past the tightening phase after 450 bp worth of Fed Funds increases. The numbers reported in February have many investors, including those that trade currencies, precious metals, stocks, bonds, and other commodities less certain about the Fed calling for a cease fire in its inflation battle.

Of course, this new trend is young, it can conceivably be unwound in an instant in a changing world with many concerns outside and away from price increases.

Paul Hoffman

Managing Editor, Channelchek

Sources:

https://app.koyfin.com/charts/

https://www.bls.gov/

The Record Levels of Cash Held by Investors May Not Indicate a Bear Market

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Image Credit: Pictures of Money (Flickr)

Investors Receiving a 5% Yield are Losing to Inflation

The CPI inflation report and the Fed’s relentless increases in Fed funds levels have pushed the six-month US Treasury Bill (T-Bill) above 5%. This is the first time since 2007 that this low-risk investment has topped 5%. Last year on this date, the six-month T-Bill was 0.76%. While the stock market is concerned that higher borrowing costs will have the Fed’s intended effect of slowing demand, rates are reaching a point where another concern creeps in. The concern is will traditional stock investors lay back and be satisfied getting paid interest.  

More likely, the high cash position represents “dry powder” waiting for an opportunity.

Short Term Rates

Money Market fund assets were $4.81 trillion for the week ended Wednesday, February 8, according to the Investment Company Institute. Just shy of the record MF balances reported in January. Higher than average cash levels have often been thought of as a bullish sign as it represents potential to drive stock prices up when flows toward equities increase.

This may be part of the situation as we come off a dismal 2022 for equities, but there is likely something else incentivizing the retreat to safety. The higher interest rates are in the short end of the curve, investors are getting paid to retreat. High-yielding cash equivalents with six-month T-Bills now at 5% (10-year Treasuries are only 3.75%) may be more than a parking place. It may represent an alternative investment with a much more assured return.

Ten Year Quarterly Returns S&P 500

Source: Macrotrends

Is 5% an Acceptable Return?

With inflation at 6.4%, the answer is no. But it is definitely preferable to seven of the periods on the 10-year chart above. And with January’s consumer price index (CPI) report revealing signs of sticky to reaccelerating inflation, the Federal Reserve is more likely to be hiking rates for longer than expected.

For investors looking to invest for longer periods, the stock market handily beats inflation. In other words, for the various time frames below, S&P 500 investors did not see their assets erode due to inflation.

Beating inflation is foundational to investing. Far exceeding it is the goal of many. Investors are not doing this choosing cash, in fact they are choosing to lose buying power rather than risk that the market doesn’t perform as it has historically.

S&P 500 Return for Periods 5-Years to 30-Years

Source: Macrotrends

Take Away

Data released on Tuesday February 14 showed the inflation rate (CPI) slowed to 6.4% in January. The cost of goods and services rose 0.5% during the month. The half percentage is the largest one month erosion of purchasing power in three months.

Investors content with 4%-5% returns should consider that they are losing ground to persistent inflation.

Investors with a five-year time horizon or longer should weigh the risks of earning yields below the inflation rate to the ups and downs of stocks. In fact, as more do, the 4-5 trillion in cash can make or quite a bull market.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value=2022

https://www.bls.gov/news.release/archives/cpi_01162008.pdf

https://www.cnbc.com/2023/01/18/investors-are-holding-near-record-levels-of-cash-and-may-be-poised-to-snap-up-stocks.html

https://www.ici.org/research/stats/mmf

https://www.nerdwallet.com/article/investing/average-stock-market-return#:~:text=The%20average%20stock%20market%20return%20is%20about%2010%25%20per%20year,other%20years%20it%20returns%20less.

The Week Ahead – Inflation (CPI), Jobs, and 13-f Holdings Reports

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Will the Inflation Numbers on Valentine’s Cause the Market to See Red?

As earnings season fades investors that like to get a glimpse into the portfolios of successful money managers will look for the 13-f filings of some of the most followed investors as they are made available. Tuesday and Wednesday should bring Michael Burry’s and Warren Buffet’s filing. The CPI report on Tuesday is expected to show a continuation of inflation tapering. The Jobs report on Thursdays has been missing consensus, it has the potential to either calm or rattle the markets.

Monday 2/13

  • With no consequential economic releases, market direction may take its tone from traders positioning ahead of Tuesday’s CPI report.

Tuesday 2/14

  • 8:30 AM ET, January’s headline CPI rate is expected to increase month to month by 0.5% after a .1% decline experienced in December, and year-over-year at 6.2% versus 6.5% the prior 12 months. Ex-food and energy (core rate) is expected to show unchanged at a 5.5% annual rate versus 5.7% the prior 12 months.
  • In previous years Michael Burry has made a public filing of Scion Asset Managements 13-f holdings on Valentine’s Day. Warren Buffet of Berkshire Hathaway will make available his changed positions. This filing is also likely on Tuesday or perhaps Wednesday.

Wednesday 2/15

  • 9:15 AM ET, Industrial Production, which includes data for Manufacturing and Capacity Utilization has been contracting. January’s consensus estimates are for monthly gains of 0.5% for production and 0.4% for manufacturing and would be a welcome sign for those fearing a  recession. The positive direction would be welcome after December’s monthly decline of 0.7% overall and 1.3% for manufacturing. Capacity utilization is expected to remain at a non-inflationary 78.8%.
  • 10:00 AM ET, Business Inventories data for December are expected to rise 0.3% following a 0.4% expansion in November. Intentional inventory growth can be a sign of business optimism surrounding future sales. If unintended inventory accumulation occurs, then production will probably be throttled back as inventories are worked down. This is why Business Inventories a leading economic indicator.
  • 10:00 AM ET, The Housing Market Index fell each month in 2022. The weak streak ended in January, as it rose 4 points to 35. February’s consensus is a further but smaller 1-point improvement to 36. The Housing Index is a monthly composite that tracks home builder assessments of present and future sales along with buyer traffic
  • 10:00 AM ET, Atlanta Fed Business Inflation Expectations survey provides a monthly measure of year-ahead inflation expectations and inflation uncertainty from the perspective of firms. The survey also provides a monthly gauge of firms’ current sales, profit margins, and unit cost changes. The year over year estimate is for 3%.

Thursday 2/16

  • 8:30 AM ET, Jobless Claims, including Initial Claims and Continuing Claims, have been a big focus of the market as unemployment is running at a historically low pace. The consensus is for growth in Jobless levels to 199,000 versus 196,000 the prior week. Overall low claims would seem to be good news for the economy. The problem now is that it is worrisome for a Fed that views current inflationary pressures, including wage pressures unacceptably high.

Friday 2/17

  • 8:30 AM ET, The Index of Leading Indicators has been in steep decline; it is expected to fall further, but less steeply, by 0.3 percent in January versus a fall of 0.8% in December.

What Else

Investors with interest in telecommunications company Comtech (CMTL) and located in South Florida, may be able to attend one of four special presentations by management on Monday or Tuesday. Get information here to see if this is suited for you.

Monday, February 20th, is a holiday, and the US markets will be closed.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.thearmchairtrader.com/macroeconomic-news-6feb23/

https://us.econoday.com/byweek.asp?cust=us

Wage Inflation, Labor Shortages, and Who Stopped Working

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Image Credit: Mr. Blue MauMau (Flickr)

Is the Mismatch in Workers and Open Jobs Proving to Be Transitory?

Inflation has been the most bearish word for the stock and bond markets over the past year or more. Shortly after many of the supply chain issues cleared up, and the cargo ships were no longer stacked up outside of major ports, attracting scarce workers with higher pay became a growing cause of inflationary pressure. At the end of November 2022, Federal Reserve Chair Jerome Powell stated that “job openings exceed available workers by about 4 million.” That number has now grown to 4.7 million after the continued strengthening of the market for qualified labor.

This mismatch, depicted in the Fed Data below, between available positions and workers to fill them, developed a more inflationary trend. The graph depicts the mismatch of labor supply and demand and the extent that it has worsened.

When the civilian labor force is greater than employment plus job openings, the economy has an immediate capacity to fill open positions. Currently, the employment level plus job openings are at 170.5 million, while the total labor force is at 165.8 million. Thus the 4.7 million quoted earlier. There are a whopping 4.7 million more jobs available compared to people available to fill them.

The civilian labor force, the amount of people working or looking for a job, is shown below in red; the current employment level plus the number of job openings is shown in blue.

.

Source: St. Louis Federal Reserve

Labor Participation Hesitancy

The pandemic has been emphasized as a cause of this not-very-transitory labor shortage, but the trends in labor demand and labor supply in the graph above indicate that demand was already outpacing supply as the US entered 2018. This was two years before the novel coronavirus hit US shores. Back then the mismatch was about one million workers fewer than jobs available before the economic disruption.

As the US began to move toward business-as-usual, news and market analysts offered many explanations for the labor shortage. These included childcare problems, health concerns, minimum wage pushback, and even a wave of new retirees.

The visual below shows the change experienced in the labor force participation rate (LFPR) for specific age groups: 20 to 24 years old, 25 to 54 years old, and 55+ years old. By subtracting the most recent LFPR from that of January 2020 we get the percentage-point change in labor force participation relative to the month just before the pandemic began impacting businesses.

When the pandemic hit, the sharpest decline in the LFPR was for workers between the ages of 20 and 24. Their LFPR decreased from 73% to 64.4% in 4 months before increasing again. However, at the end of 2022, the LFPR for 20- to 24-year-olds still hadn’t fully recovered and remained 1.7 percentage points below its January 2020 value.

This overall pattern is similar but less extreme for the other age groups. Although no age group fully recovered by the end of 2022, the 25-54 group was closest, at 0.7 percentage points below its January 2002 level. There’s been speculation older workers retired early (and permanently) during the pandemic, and the 55+ group remained 1.4 percentage points below its January 2020 level as of December 2022, with no sign of further recovery.

Source: St. Louis Federal Reserve

Take Away

The mechanisms that cause inflation are widely understood. If there is a shortage of goods because of the supply chain, sellers can ask more for the product. If the cost of producing goods or providing services increase, perhaps because of the cost of labor, the seller may try to pass those higher costs along. On the demand-pull side, if there is an abundance of currency, this increases demand for goods and services and is also inflationary.

While the Fed has been waging a fight against rising prices by removing liquidity and ratcheting up the cost of money (interest rates), the number of open jobs compared to the number of workers available to fill them has widened.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.federalreserve.gov/newsevents/speech/powell20221130a.htm

https://www.bls.gov/news.release/empsit.nr0.htm

https://fred.stlouisfed.org/searchresults/?st=unemployment%20rate&isTst=1

Michael Burry Warns Against the Market Hoping for Economic Weakness

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Image Credit: Yahoo (YouTube)

Further Evidence of his Future Outlook is Provided By “The Big Short” Michael Burry

It has been three-plus years since Michael Burry first warned that index funds’ popularity is creating distorted valuations of stocks included in the larger indexes. The reason for his warning is fund managers need to own the companies in the index. This creates buying pressure on stocks that might not otherwise be as strong of a buy candidate. In other words, investments are not being purchased on their own merit and, therefore could be thought of as overvalued. He called this the “passive investment bubble,” and he is still warning investors about a stock market investment bubble.

“Difference between now and 2000 is the passive investing bubble that inflated steadily over the last decade,” he tweeted late last year. “All theaters are overcrowded, and the only way anyone can get out is by trampling each other. And still, the door is only so big,” Burry said in October 2022. While his SEC filings show he is not opposed to owning individual stocks with a unique opportunity, he’s expecting a market collapse that dwarfs the dot-com crash because there’s so much money parked in index funds.

This week Burry provided a backup argument to his thesis in the form of a chart. The Bloomberg produced chart showed the S&P’s 40% plunge between February 2001 and October 2002. The S&P data was plotted alongside the sharp decline in the Fed Funds overnight benchmark interest rate. Burry’s latest tweet suggests a feeling of deja-vu that includes the stock market’s surge in early 2001, when rates were 6%. There seems to be concern that market participants are looking for enough weakness for the Fed to drop rates. The chart, and his written message is one to be careful what you wish for.

His tweet read, “This time is different.” This apparent sarcasm could be read, if you want lower rates, it may come at a cost.

Image: @michaeljburry (Twitter)

Burry seems to expect enough economic weakness that the Fed will again ratchet down rates in a hurry. The poor economic scenario would likely cause the S&P 500 to tumble.

Take Away

Higher rates encourage traditional savings, which then becomes money not used to stimulate the economy.  It also slows growth by making borrowing more expensive. This dampens demand and increases the risk of a bad recession. Burry, a widely followed hedge fund manager has been warning of the broader market taking a huge hit.

Burry has noted that blistering but brief rallies are common during market downturns.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.thestreet.com/investors/jim-cramer-michael-burry-tweet-seemingly-opposite-views-on-the-market-15-minutes-apart

https://markets.businessinsider.com/news/stocks/big-short-michael-burry-stock-rally-dot-com-bubble-crash-2023-2

https://nypost.com/2022/10/03/michael-burry-flags-passive-investing-bubble-as-market-risk/

How is the Economy Really Doing (Just the Facts)?

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Image Credit: USA Facts

Do the Most Current Economic Measurements Suggest a Trend Toward Recession or Growth?

How is the US Economy Doing?

  • US GDP increased 2.1% in 2022 after increasing 5.9% in 2021.
  • Year-over-year inflation, the rate at which consumer prices increase, was 6.5% in December 2022.
  • The Federal Reserve raised interest rates seven times in 2022 and again on February 1, 2023 to curb inflation, increasing the target rate from near zero to 4.5-4.75%.
  • When accounting for inflation, workers’ average hourly earnings were down 1.7% in December 2022 compared to a year prior.
  • The ratio of unemployed people to job openings remained at or near record lows throughout 2022.
  • The unemployment rate was 4.0% at the beginning of 2022 and ended the year at 3.5%.
  • The labor force participation rate remains almost one percentage point below February 2020.
  • From January to November 2022, the US imported $889.9 billion more in goods and services than it exported. This is 7% higher than the trade deficit in 2021 for the same months.

US GDP increased 2.1% in 2022 after increasing 5.9% in 2021

Gross domestic product (GDP) fell in the first half of 2022 but grew in the second half. GDP reached $25.5 trillion in 2022.

US GDP

Year-over-year inflation, the rate at which consumer prices increase, was 6.5% in December 2022

That’s down from June 2022’s rate of 9.1%, the largest 12-month increase in 40 years. Inflation grew at the beginning of the year partly due to rising food and energy prices, while housing costs contributed throughout 2022.

CPI-U

The Federal Reserve raised interest rates seven times in 2022 and again on February 1, 2023 to curb inflation, increasing the target rate from near zero to 4.5-4.75%

Rate increases make it more expensive for banks to borrow from each other. Banks pass these costs on to consumers through increased interest rates. Read more about how the Federal Reserve tries to control inflation here.

Fed Funds Rate

When accounting for inflation, workers’ average hourly earnings were down 1.7% in December 2022 compared to a year prior

Inflation-adjusted average hourly earnings fell in all industries except information and leisure and hospitality, where earnings were flat.

Hourly Earnings

The ratio of unemployed people to job openings remained at or near record lows throughout 2022

In a typical month from March 2018 and February 2020, there were between 0.8 and 0.9 unemployed people per job opening. But after more than quadrupling in April 2020 at the onset of the pandemic, the ratio fell and settled from December 2021 to December 2022 to between 0.5 and 0.6 unemployed people per job opening, the lowest since data first became available in 2000.

Unemploymed Ratio

The unemployment rate was 4.0% at the beginning of 2022 and ended the year at 3.5%

It decreased most for Black and Asian people, 1.2 and 1.1 percentage points, respectively. Black people still have unemployment rates higher than the rest of the nation.

Categorized Unemployment Rate

The labor force participation rate remains almost one percentage point below February 2020

An additional 2.5 million workers would need to be in the labor force for the participation rate to reach its pre-pandemic level.

From January to November 2022, the US imported $889.9 billion more in goods and services than it exported. This is 7% higher than the trade deficit in 2021 for the same months

During this time, the goods trade deficit reached $1.1 trillion. Complete 2022 data is expected on February 7, 2023.

Trade Balance

This content was republished from USAFacts. USAFacts is a not-for-profit, nonpartisan civic initiative making government data easy for all Americans to access and understand. It provides accessible analysis on US spending and outcomes in order to ground public debates in facts.

The Week Ahead – Powell Speaks, Jobless Claims, Consumer Sentiment

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The Fed Chair’s Comments May be the Most Critical Market Event of the Week  

It’s a quiet week for economic data. If the market takes a direction this week, it may have to take its lead from something other than statistics that indicate economic strength or weakness. This could be a Fed governor speaking, or a central bank outside of the US altering its hawkish stance.

Monday 2/6

  • With no consequential economic releases, market direction may take its tone from earnings reports from a wide swath of industries.

Tuesday 2/7

  • 11:00 AM ET, New York Federal Reserve inflation expectations. 
  • 3:00 PM ET, Consumer Credit, or more definitively, the installment credit outstanding by consumers is expected to have increased by $25 billion in December versus  November’s $27.9 billion increase. There is such a long delay reporting this number that it seldom has a market impact.  
  • Fed Chair Jerome Powell will be speaking at the Economic Club of Washington.

Wednesday 2/8

  • 10:00 AM ET, Wholesale Inventories revision for December is in line with the first estimate of 1%. Wholesale sales and inventory data can provide investors a chance to look below the surface of the consumer economy. Activity at the wholesale level can then be a precursor of consumer trends.

Thursday 2/9

  • 8:30 AM ET, Jobless Claims, including Initial Claims and Continuing Claims, have been a big focus of the market as unemployment is running at a historically low pace. The consensus is for growth in Jobless levels to 190,000 versus 183,000 the prior week. Overall low claims would seem to be good news for the economy. The problem now is that it is except that it is worrisome for a Fed that views current inflationary pressures, including wage pressures unacceptably high.

Friday 2/10

• 10:00 AM ET, The University of Michigan’s Consumer Survey Center questions households each month on their assessment of current conditions and expectations of future conditions. Consumer sentiment is not expected to show much improvement, at a consensus 65.0 in the first reading for February versus 64.9 in January.

What Else

The FOMC meeting that ended on February 1 was the last before Chair Powell delivers the semiannual monetary policy testimony in late February or early March (not yet set). Any remarks by Fed officials in the February 6 week should be viewed in that context. Powell and associates will not want to confuse any upcoming message given at the semiannual Monetary Policy Report to Congress. Whatever is said is likely to foreshadow what will be in the report when he speaks before the Senate Banking Committee and the House Financial Services Committee.

Paul Hoffman

Managing Editor, Channelchek

https://www.thearmchairtrader.com/macroeconomic-news-6feb23/

https://us.econoday.com/byweek.asp?cust=us

Ongoing Increases in the Overnight Interest Rate Target Can be Expected Says FOMC Statement

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Image Source: Federal Reserve (Flickr)

Jerome Powell and FOMC Will “continue to monitor the implications of incoming information”

The Federal Open Market Committee (FOMC) voted to raise overnight interest rates from the previous target of 4.25% – 4.50% to the new target of 4.50% – 4.75%. This was announced at the conclusion of the Committee’s first scheduled meeting of 2023. The monetary policy shift in bank lending rates was as expected by economists and the markets as the overwhelming consensus was for a 25 bp move.  It has been less than 12 months since the Fed began this tightening cycle, overnight rates since the beginning of last year have increased from near 0.00% to the current target of up to 4.75%.

One recent market focus has been that inflation has been, by most measures, trending lower each month.  While lower increases may suggest that inflation is successfully being wrung out of the system, Powell and the other FOMC members have a 2% target for inflation which guides their policy. The current level is more than two times as high. The art of being the nation’s top bankers and economists trying to provide a soft landing for the still strong economy, is difficult. The result of the actions taken by the Fed can only be seen in the rearview mirror, months after the action.

Synopsis of Fed Decisions

The Board of Governors of the Federal Reserve System voted unanimously to approve a 1/4 percentage point increase in the primary credit rate to 4.75 percent, effective February 2, 2023. In a related decision, the Board of Governors of the Federal Reserve System voted unanimously to raise the interest rate paid on reserve balances to 4.65 percent, effective February 2, 2023.

Text from Federal Reserve’s Statement February 1, 2023

Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation has eased somewhat but remains elevated.

Russia’s war against Ukraine is causing tremendous human and economic hardship and is contributing to elevated global uncertainty. The Committee is highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 4-1/2 to 4-3/4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the extent of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Take-Away

Higher interest rates can weigh on stocks as companies that rely on borrowing may find their cost of capital has increased. The risk of inflation also weighs on the markets. Additionally, investors find that alternative investments that pay a known yield may, at some point, be preferred to equities. For these reasons, higher interest rates are of concern to the stock market investor. However, an unhealthy, highly inflationary economy also comes at a cost to the economy, businesses, and households.

The statement suggests the Fed continues to remain data dependent, but expects further increases will follow. The statement did not provide strong guidance as to what to expect following future meetings.

Chairman Powell’s 2:30 PM ET press conference can be viewed here.

Paul Hoffman

Managing Editor, Channelchek

Will February Follow Through On January’s Gains

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Image Credit: Ben Welsh (Flickr)

January’s Stock Market Performance Bodes Well for the Rest of 2023

The stock market has put in a solid January in terms of overall performance. Following month after negative month last year, this is a welcome relief for those with money in the market which is beginning to look welcoming to those that have been on the sidelines. While the Fed is still looming with perhaps another 50-75 basis points in rate hikes left to implement over the coming months, the market has been resilient and has already made up for some of last year’s lost ground.

Source: Koyfin

For the month (with an hour left before market close on January 31), the Nasdaq 100 is up over 10.8% for the month. Over 10%  would be a good year historically, of course averaging in last year, it is still solidly underperforming market averages. The small-cap Russell 2000 index is also above 10%. Small-caps have underperformed larger cap stocks over several years and are seen to have more attractive valuations now than large caps as well as other fundamental strengths. These include a higher domestic US customer base in the face of a strong dollar, fewer borrowings that would be more costly with the increased rate environment, and an overall expectation that the major indexes will revert to their mean performance spreads which the small-cap indexes have been lagging. The S&P 500, the most quoted stock index is up over 6% in January, and the Dow 30 Industrials are up almost 2.4%.

Rate Increases

The stock and bond markets hope for a solid sign that the FOMCs rate increases will cease. The reduced fear of an ongoing tightening cycle will calm the nervousness that comes from knowing that higher rates hurt the consumer, increases unemployment, reduces spending and therefore hurts earnings which are most closely tied to stock valuations.

January Historically

January rallies, on their own, statistically have been a good omen for the 11 months ahead.  When the S&P 500 posts a gain for the first month of the year, it goes on to rise another 8.6%, on average for the rest of the year according to statistics dating back to 1929.  In more than 75% of these January rally years, the markets further gained during the year.

Other statistics indicate a bright year to come for the market as well. Using the S&P 500, it rallied for the final five trading days of last year and the first two of 2023, it gained for first five trading days of the new year, and rallied through January. When all three of these have occurred in the past, after a bear market (20%+ decline), the index’s average gain for the rest of the year is 13.9%. In fact it posted positive returns in almost all of the 17 post-bear market years that were ushered in with similar gains.

Follow Through

Beyond history, there is a reason for the follow-through years. January rallies are signs of confidence, they indicate that self-directed investors and professional money managers are buying stocks at the lower prices. It suggests they have a strong enough belief that conditions that caused the bear market have or will soon reverse.  

And this is quite possibly where the markets are at today. The lower valuations seem attractive, this is especially true of the overly beaten down Nasdaq 100 stocks and the small-caps that had been trailing in returns since before the pandemic.

Federal Reserve Chair Powell is looking to make money more expensive in order to slow an economy that is still exhibiting inflationary pressures. He is not, however, looking to crush the stock market. Fed governors seem to be concerned that the bond market prices haven’t declined to match their tightening efforts, but a healthy stock market helps the Fed by giving it latitude to act. Powell will take the podium post FOMC meetings eight times this year.

Each time his intention will be to usher in a long term healthy economy, with reasonable growth, low inflation, and jobs levels that are in line with consumer confidence.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.ndr.com/news

https://tdameritradenetwork.com/video/how-to-read-the-technicals-before-the-market-changes

https://www.marketwatch.com/story/last-years-stock-market-volatility-has-carried-over-into-january

https://www.barrons.com/articles/stocks-january-gains-what-it-means-51675185839?mod=hp_LATEST

Game of Chicken With the US Economy Getting Under Way

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Image Credit: US Embassy, South Africa (Flickr)

US Debt Default Could Trigger Dollar’s Collapse – and Severely Erode America’s Political and Economic Might

Republicans, who regained control of the House of Representatives in November 2022, are threatening to not allow an increase in the debt limit unless spending cuts are agreed to. In so doing, there is a risk of the U.S. government could move into default.

Brinkmanship over the debt ceiling has become a regular ritual – it happened under the Clinton administration in 1995, then again with Barack Obama as president in 2011, and more recently in 2021.

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of, Michael Humphries, Deputy Chair of Business Administration, Touro University

As an economist, I know that defaulting on the national debt would have real-life consequences. Even the threat of pushing the U.S. into default has an economic impact. In August 2021, the mere prospect of a potential default led to an unprecedented downgrade of the the nation’s credit rating, hurting America’s financial prestige as well as countless individuals, including retirees.

And that was caused by the mere specter of default. An actual default would be far more damaging.

Dollar’s Collapse

Possibly the most serious consequence would be the collapse of the U.S. dollar and its replacement as global trade’s “unit of account.” That essentially means that it is widely used in global finance and trade.

Day to day, most Americans are likely unaware of the economic and political power that goes with being the world’s unit of account. Currently, more than half of world trade – from oil and gold to cars and smartphones – is in U.S. dollars, with the euro accounting for around 30% and all other currencies making up the balance.

As a result of this dominance, the U.S. is the only country on the planet that can pay its foreign debt in its own currency. This gives both the U.S. government and American companies tremendous leeway in international trade and finance.

No matter how much debt the U.S. government owes foreign investors, it can simply print the money needed to pay them back – although for economic reasons, it may not be wise to do so. Other countries must buy either the dollar or the euro to pay their foreign debt. And the only way for them to do so is to either to export more than they import or borrow more dollars or euros on the international market.

The U.S. is free from such constraints and can run up large trade deficits – that is, import more than it exports – for decades without the same consequences.

For American companies, the dominance of the dollar means they’re not as subject to the exchange rate risk as are their foreign competitors. Exchange rate risk refers to how changes in the relative value of currencies may affect a company’s profitability.

Since international trade is generally denominated in dollars, U.S. businesses can buy and sell in their own currency, something their foreign competitors cannot do as easily. As simple as this sounds, it gives American companies a tremendous competitive advantage.

If Republicans push the U.S. into default, the dollar would likely lose its position as the international unit of account, forcing the government and companies to pay their international bills in another currency.

Loss of Political Power Too

Since most foreign trade is denominated in the dollar, trade must go through an American bank at some point. This is one important way dollar dominance gives the U.S. tremendous political power, especially to punish economic rivals and unfriendly governments.

For example, when former President Donald Trump imposed economic sanctions on Iran, he denied the country access to American banks and to the dollar. He also imposed secondary sanctions, which means that non-American companies trading with Iran were also sanctioned. Given a choice of access to the dollar or trading with Iran, most of the world economies chose access to the dollar and complied with the sanctions. As a result, Iran entered a deep recession, and its currency plummeted about 30%.

President Joe Biden did something similar against Russia in response to its invasion of Ukraine. Limiting Russia’s access to the dollar has helped push the country into a recession that’s bordering on a depression.

No other country today could unilaterally impose this level of economic pain on another country. And all an American president currently needs is a pen.

Rivals Rewarded

Another consequence of the dollar’s collapse would be enhancing the position of the U.S.‘s top rival for global influence: China.

While the euro would likely replace the dollar as the world’s primary unit of account, the Chinese yuan would move into second place.

If the yuan were to become a significant international unit of account, this would enhance China’s international position both economically and politically. As it is, China has been working with the other BRIC countries – Brazil, Russia and India – to accept the yuan as a unit of account. With the other three already resentful of U.S. economic and political dominance, a U.S. default would support that effort.

They may not be alone: Recently, Saudi Arabia suggested it was open to trading some of its oil in currencies other than the dollar – something that would change long-standing policy.

Severe Consequences

Beyond the impact on the dollar and the economic and political clout of the U.S., a default would be profoundly felt in many other ways and by countless people.

In the U.S., tens of millions of Americans and thousands of companies that depend on government support could suffer, and the economy would most likely sink into recession – or worse, given the U.S. is already expected to soon suffer a downturn. In addition, retirees could see the worth of their pensions dwindle.

The truth is, we really don’t know what will happen or how bad it will get. The scale of the damage caused by a U.S. default is hard to calculate in advance because it has never happened before.

But there’s one thing we can be certain of. If there is a default, the U.S. and Americans will suffer tremendously.

Do Some Money Measurements Double Count?

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Image Credit: John (Flickr)

Can Correlations Help Define Money?

According to popular thinking, the government’s definition of money is of a flexible nature. Sometimes it could be M1, and at other times it could be M2 or some other M money supply. M1 includes currency and demand deposits. M2 includes all of M1, plus savings deposits, time deposits, and money market funds. By popular thinking what determines whether M1, M2, or some other M is considered money is whether it has high correlation with key economic data such as the gross domestic product (GDP).

However, since the early 1980s, correlations between various definitions of money and the GDP have broken down. The reason for this breakdown, many economists believe, is that financial deregulation has made the demand for money unstable. Consequently, the usefulness of money as a predictor of economic activity has significantly diminished.

Some economists believe that the relationship between money supply and the GDP could be strengthened by assigning weights to money supply components. The Divisia indicator, named after the French economist François Divisia, adjusts for differences in the degree to which various components of the monetary aggregate serve as money. This, in turn, supposedly offers a more accurate picture of what is happening to money supply.

The primary Divisia monetary indicator for the US is M4. It is a broad aggregate that includes negotiable money market securities, such as commercial paper, negotiable CDs, and T-bills. By assigning suitable weights, which are estimated by means of quantitative methods, it is held that one is likely to improve the correlation between the weighted monetary gauge and economic indicators.

Consequently, one could employ this monetary measure to ascertain the future course of key economic indicators. However, does it make sense?

Defining Money

No definition of money can be established by means of a correlation. A definition is supposed to present the essence of the subject being identified.

To establish the definition of money, we must determine how a money-using economy came about. Money emerged because barter could not support the market economy. A butcher who wanted to exchange his meat for fruit would have difficulty finding a fruit farmer who wanted his meat, while the fruit farmer who wanted to exchange his fruit for shoes might not have been able to find a shoemaker who wanted his fruit.

The distinguishing characteristic of money is that it is the general medium of exchange. It has evolved from the most marketable commodity. According to Murray Rothbard:

Just as in nature there is a great variety of skills and resources, so there is a variety in the marketability of goods. Some goods are more widely demanded than others, some are more divisible into smaller units without loss of value, some more durable over long periods of time, some more transportable over large distances. All of these advantages make for greater marketability. Eventually, one or two commodities are used as general media—in almost all exchanges—and these are called money.

With money, the butcher can exchange his meat for money and then exchange money for fruits. Likewise, the fruit farmer could exchange his fruit for money. With the obtained money, the fruit farmer can now exchange it for shoes. The reason why all these transactions become possible is because money is the most marketable commodity (i.e., the most accepted commodity).

According to Rothbard:

Money is not an abstract unit of account, divorceable from a concrete good; it is not a useless token only good for exchanging; it is not a “claim on society”; it is not a guarantee of a fixed price level. It is simply a commodity.

It follows then that all other goods and services are traded for money. This fundamental characteristic of money is contrasted with other goods. For instance, food supplies the necessary energy to human beings. Capital goods permit the expansion of the infrastructure that, in turn, permits the production of a larger quantity of goods and services. Contrary to the mainstream thinking, the essence of money has nothing to do with financial deregulation as this essence will remain intact in the most deregulated of markets.

Some commentators maintain that money’s main function is to fulfill the role of a means of savings. Others argue that its main role is to be a unit of account and a store of value. While all these roles are important, they are not fundamental. The basic role of money is to be a medium of exchange, with other functions such as unit of account, a store of value, and a means of savings arising from that role.

Through an ongoing selection process over thousands of years, individuals have settled on gold as money. In today’s monetary system, the money supply is no longer gold, but metal coins and paper notes issued by the government and the central bank. Consequently, coins and notes constitute money, known as cash, that is employed in transactions.

Distinction between Claim and Credit Transactions

At any point in time, an individual can keep money in a wallet or somewhere at home or deposit the money with a bank. In depositing money, an individual never relinquishes ownership over the money having an absolute claim over it.

This contrasts with a credit transaction, in which the lender of money relinquishes a claim over one’s money for the duration of the loan. As a result, in a credit transaction, money is transferred from a lender to a borrower. Credit transactions do not alter the amount of money. If Bob lends $1,000 to Joe, the money is transferred from Bob’s demand deposit or from Bob’s wallet to Joe’s possession.

Why Are Various Popular Definitions of Money Misleading?

Consider the money M2 definition, which includes money market securities, mutual funds, and other time deposits. However, investing in a mutual fund is, in fact, an investment in various money market instruments. The quantity of money is not altered because of this investment; only the ownership of money has temporarily changed. Hence, including mutual funds as part of money results in double counting.

The Divisia monetary gauge is of little help in establishing what money is. Because this indicator was designed to strengthen the correlation between monetary aggregates such as M4 and other Ms with an economic activity indicator, the Divisia gauge can better be seen as an exercise in curve fitting.

The Divisia of various Ms, such as the Divisia M4, does not address the double counting of money. The M4 is a broad aggregate and includes a mixture of claim and credit transactions (i.e., a double counting of money). This generates a misleading picture of what money is.

Applying various weights to the components of money cannot make the definition of money valid if it is created from erroneous components. Furthermore, even if the components were valid, one does not improve the money definition by assigning weights to components.

The introduction of electronic money has supposedly introduced another confusion regarding the definition of money. It is believed that electronic money is likely to make the cash redundant. We hold that electronic money is not new money, but rather a new way of employing existing monetary transactions. Regardless of these new ways of employing money, definitions and the role of money do not change.

Conclusion

The attempt to strengthen the correlation between various monetary aggregates and economic activity by using variable weighting of money supply components defeats the definition of money. The essence of money cannot be established by means of a statistical correlation, but rather by understanding what money is about.

About the Author

Frank Shostak is an Associated Scholar of the Mises Institute. His consulting firm, Applied Austrian School Economics, provides in-depth assessments and reports of financial markets and global economies. He received his bachelor’s degree from Hebrew University, his master’s degree from Witwatersrand University, and his PhD from Rands Afrikaanse University.  

Debt Ceiling Risk and Solutions to be Addressed by Biden and McCarthy

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Image: President Biden reads newspaper before a phone call with Kevin McCarthy, Aug. 23, 2021 (The White House)

Could the Debt Ceiling Challenges be Ironed Out Before the Eleventh Hour?

The market-moving potential of key meetings in Washington on Wednesday, February 1st, includes more than the FOMC decision on monetary policy. Up the road from the Federal Reserve building, also scheduled for the first of the month, will be another important meeting for the markets. House of Representatives Speaker Kevin McCarthy will be headed to the Oval Office for a discussion to resolve other risks to the US economy, risks that could quickly spin out of control. High on the list is the national debt limit. Without a plan, the inability for the government to borrow above the current debt ceiling, could impact trust in the credit rating of US debt. This would move bond prices lower as rates would naturally rise at even the smallest prospect of a US default.  

Why It’s Critical to Markets

A debt limit increase would allow the government to finance existing obligations. These obligations have, as in the past, expanded beyond the borrowing cap imposed on the US Treasury. An inability to roll existing maturing debt or afford additional interest rate costs would cause a default. The reverberations of this can not be understated as US Treasuries, like US currency, is the backbone of the worlds financial system.

An actual default could precipitate a mega financial crisis, threatening jobs, asset values, and trust.  

The US reached its technical borrowing limit of $31.4 trillion in January. US Treasury Secretary Yellen enacted planned accounting moves that will allow the federal government to pay its bills until sometime in June by postponing some obligations. Before then, a solution must be devised by lawmakers that would then be signed by the President in order for the government to take on new debt and fund its responsibilities.

The Meeting Agenda

President Biden and House of Representatives Speaker Kevin McCarthy will meet at the White House to find common negotiating ground to avert a default. They currently seem far apart on a potential solution as the President’s party wishes to raise the debt ceiling quickly and resume business as usual in DC, while many in the House Speaker’s party are looking for concessions and spending cuts before they agree to raise the borrowing limit.

Republican lawmakers don’t currently support a measure that would let the country pay its debts unless there is agreement on various spending cuts going forward. The White House, which must sign or veto anything passed in Congress, has said raising the debt limit is critical and non-negotiable, citing the risk to the US economy from a default.

Both Biden and McCarthy will want to come away from this meeting with something their constituents and the onlooking financial markets can be comfortable with, and at the same time provides assurance to the world that is also looking on.

Congress has always passed an increase in the debt limit. Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or change the definition of the debt limit. Congressional leaders in both parties have believed in the end that it is best. However, the negotiations tend to go to the eleventh hour with escalating showmanship on all sides.

The eleventh hour comes sometime in June. Skeptics of any success of this face-to-face talk have a long history on which to hang their skepticism. However, McCarthy being new to his role and Biden having an aggressive spending agenda may help to shape a quicker outcome than in the past.

On Sunday, January 9th, McCarthy said that Republicans would not allow a US default that cuts into Social Security and Medicare, this would be “off the table” in any debt ceiling negotiations.

“The President will ask Speaker McCarthy if he intends to meet his Constitutional obligation to prevent a national default, as every other House and Senate leader in US history has done,” a White House spokesperson said.

The statements following, both by the White House and the Speakers camp, may cause a sigh of relief or elevate the level of panic.

Politics Involved

House Speaker McCarthy, in order to be elected speaker, agreed to rules that made it easier for his party to oust him over policy disagreements. He said he’d focus on discretionary spending, which has increased dramatically in the past two years with infrastructure and semiconductor legislation and a green-energy bill supported by Democrats.

“I think everything, when you look at discretionary, is sitting there,” McCarthy said. “We shouldn’t just print more money, we should balance our budget. So I want to look at every single department. Where can we become more efficient, more effective and more accountable?”

Biden, who is contemplating seeking re-election in 2024, has been sharply critical of McCarthy’s Republican caucus. He characterized them as “fiscally demented” earlier this month, threatened to veto their legislation and accused them of trying to balloon the deficit, favoring billionaires, raising middle-class taxes and threatening benefit programs.

Take Away

In the past, debt ceiling news typically made the top headline when the negotiations are truly in the eleventh hour. The meeting on Wednesday between two politicians that have a lot to gain from a successful outcome may avert a late Spring crisis and provide calm in what is already a cloudy economic environment. An agreement would be positive for the markets – lack of agreement will likely be taken as business as usual.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/debt-limit

https://www.reuters.com/world/us/biden-were-going-have-discussion-about-us-debt-with-house-leader-2023-01-20/

https://www.whitehouse.gov/cea/written-materials/2021/10/06/the-debt-ceiling-an-explainer/