Bank Reserves at Federal Reserve

Over the last several years, many analysts have argued that QE isn’t inflationary because the money that the Fed has printed has been locked up in reserve balances.  I don’t personally share this view, but it’s worth noting that recently reserve balances have been contracting and currency in circulation has been growing as banks have chosen to convert reserves to currency.  Currency in circulation is now growing at nearly a 10% annual rate.

QE3 Just Starting to Hit Fed Balance Sheet

Although QE3 was announced almost 2.5 months ago, the mortgages that the Fed has been purchasing have only just started to hit the Fed’s balance sheet over the last couple of weeks.  The monetary base has continued to hold flat, but mortgage holdings have ticked ever so slightly higher.

The Fed has agreed to purchase ~$100B worth of mortgages since September, but holdings have only increased by $40B due to the lag in time of settlement for MBS trades.  The fact that the balance sheet has mostly been unchanged suggests that we may not yet have seen the effects of QE3 in securities markets.

Nominal GDP Grew at 5.5% in 3Q12

The first revision of 3Q12 GDP was released this morning and showed that GDP grew at 2.7% annualized during the quarter, which was 0.7% better than the initial estimate.  That’s also 1.4% more than it grew in 2Q12, when it only grew by 1.3% annualized.

People often forget that the headline GDP number is reported on a “real” basis, which means that it is adjusted for inflation.  In reality, real GDP is anything but real though, since the world is measured in nominal, not real numbers (especially important for debt), and economists do a debatable job of measuring inflation anyways.

On a nominal basis GDP was up 5.5% annualized last quarter, a pretty big number!  The deflator (inflation) ran at 2.7% which is also a fairly large number in its own right.  The 5.5% growth was actually the largest quarterly increase in nominal GDP this cycle, although it’s not quite as large as it was at other points last decade.

Nominal GDP Growth
Source: BEA

Largest Powerball Jackpots in History

Tonight the lucky residents of 42 states (sadly not California) will get a shot at a $500m Powerball jackpot.  Below is a chart of all the times that the jackpot has exceeded $200m.  This has happened 28 times since 2002, about once every 134 days, or 2.7x per year.  That isn’t a whole lot different than the frequency of drawdowns on the S&P 500, which, like big jackpots, create favorable buying opportunities.  Five percent drawdowns have happened about once every 163 days since March 2009.

Is [The] Santa Claus [Rally] Real?

The end of this week will bring the end of November, and with that there is the usual seasonal talk about a Santa Claus rally in the stock market.  The logic goes that stocks usually rally between Thanksgiving and Christmas, but much like with Kris Kringle himself, it’s fair to ask the question: does the Santa Claus rally really exist?

Looking at the historical data, since 1957 December has been a positive month on average for equities.  In the past 5 years it has been especially good–powered by a nearly 11% gain in 2008 and 4% gain in 2010.  Below is the average path that the S&P 500 takes during December.  It demonstrates some Christmas magic may indeed exist–the path is even strangely sleigh like…

Happy Thanksgiving to the 1% (That probably means you)

I’m re-posting this post from last year–I haven’t changed a word.  It’s easy to forget that there was extreme bearishness then too, but after Thanksgiving 2011 we got a 5 month rally from ~1150 to ~1400.  A similar rally this year would bring us to new all time highs.

Originally posted 11/23/11:

On a day that the Dow was down 236 points, it doesn’t feel like there’s much to be thankful for.  Between Europe’s collapse, Washington’s gridlock and China’s slowdown, it seems the world is a dangerous place for investors.  Despite all the scary headlines, there is of course lots to be thankful for, even from an economic standpoint.  Most notably: we are a nation of 1%-ers.

The Occupy Wall Street movement has drawn plenty of attention to the income distribution within the United States, pitting the 99% against the 1%.  But what goes overlooked by these well meaning folks is that compared to the other 6.7B people on the planet, those occupying Wall Street probably don’t come close to being in the 99%.

In the US it takes an income of $250,000 per year to be considered a 1%-er, but if you take the global population into the calculation, the number drops to just $47,500.  Considering that median household income in the US is $50,000 per year, this means that at the very least half of Americans live in a household that earns at the 1% level.  Even the US poverty line, which is set at a family of four earning less than $22,000 is not too far from being in the global top 10%.

Compared to inequity of global income distribution, the intra-US distribution is no great injustice at all.  That is something to truly be thankful for.

Global Income Distribution
Data is from the World Bank.

HP’s Horrible Acquisition Track Record

As I’m sure most are aware, HP announced today that it would be writing-off almost the entirety of its Autonomy acquisition, which was panned from the minute it was announced and resulted in Leo Apotheker’s ousting.

In acquiring Autonomy, HP basically admitted that it set fire to about $9B.  This would be bad enough if it wasn’t for the fact that this is not the first, not the second, but the third time in a year that HP has admitted that a company it spent more than a billion dollars acquiring was worth far less than it paid for it.  In 2008, HP bought Electronic Data Systems for $13.9B and wrote that down by $9.8B last quarter.  In 2010 the company bought Palm for over $1B and shortly thereafter shut the operations down.  In all the sum of these three write-downs is worth almost as much as HP’s current market cap!

Worst of all, the carnage from the Mark Hurd/Leo Apotheker era still might not even be done yet.  In 2010 (while the company was being led by an interim CEO if memory serves) HP made three other multi-billion dollar acquisitions at big revenue multiples.  3COM, 3PAR and Arcsight could each be a candidate for billion dollar write-downs as well.

What Happens if We Don’t Go Over the Fiscal Cliff?

One thing that I think people aren’t currently appreciating about the Fiscal Cliff is that congress is mostly debating how they plan to shrink the deficit, not really if they’re going to shrink the deficit.  So, whether there’s a compromise or not, the US economy is going to be facing a similar picture in 2013: deficit reduction.  (Of course, if we don’t “go over the cliff” this deficit reduction might happen slower than in a compromise, and certainly a lack of compromise wont be good for market psychology, but from a technical spending point of view the outcomes are actually rather similar.)

In order to take a look at how the US economy has fared in past periods of deficit reduction, below is some important data linking GDP growth to deficit contraction.  The chart shows the data for every year that there has been a contraction in the deficit as a percentage of GDP since 1929.

Over that time frame there have been 42 years that the government has spent less money relative to GDP than it did in the previous year, and the good news is that in the vast majority of those years, there has still been positive GDP growth.  Real GDP only contracted in 7 of those years and Nominal GDP only contracted in 3 (two of which were in the depression).  The reason that nominal GDP has fared better is that there is actually a strong history of inflation in years of deficit reduction–something to definitely watch for in 2013.

What Happens to GDP when Deficits are lower
Source: Federal Reserve

If the deficit shrinks by the full fiscal cliff amount of ~$500B next year, that would mean that the deficit would shrink by ~3% of GDP.  Below is some data to put that into context relative to other years in which the deficit contracted by a large amount in a single year.  Many of the data points are clustered around the post WWII period (when we ran our largest deficits captured by the data), but low real GDP growth and high inflation are characteristic of most of these years.

Deficit Reduction GDP

Federal Debt Compared to Household Net Worth

Much of the recent discussion about the fiscal cliff has focused on the role of the wealthy and their obligation to shoulder the public debt load.  With the debt at $16T and the relative concentration of wealth in the US, the wealthy might not ultimately have much of a choice.  The top quintile of wealth is going to have to shoulder almost all of the load.
America is a wealthy country, so technically there is enough money to extinguish the whole debt if we needed to, but it would likely take extending the scope of taxation beyond income and into wealth.  The savings rate in the US (“leftover” income) is already very low, so there isn’t a whole lot of room to tax income more without severely impacting consumption.  There is, however, plenty of wealth, but it happens to be highly concentrated because low income households don’t save much.  The top 20% of households hold 85% of the country’s net savings.
Below is a chart of what the richest Americans’ wealth looks like in relation to the Federal debt.  The Forbes 400 could only cover ~10% of the total.  The top 1% could cover the whole amount, but it would require a one time tax of 71% of their net worth (which includes assets like real estate, which would be tricky to implement).
If Uncle Sam wanted to keep a hypothetical debt extinguishment tax to 30% of an individual household’s net worth, it would have to extend the tax across the top 20% of households, which would include households with an average net worth of ~$700k (that works out to ~210k for that household).
Source: Federal Reserve, Avondale Estimates of Net Worth Based on 2007 Wealth Concentration Statistics.
Importantly this analysis only includes today’s debt.  It does not take into account the unfunded liabilities from social security and medicare.  It’s a little scary to think that the majority of American households have almost no savings and will be absolutely dependent on these programs as elderly.  These two programs combined are estimated to have an NPV liability of ~$50T, which theoretically wipes out the net worth of the whole top 20%.  Before anyone goes into crisis mode though, all that really means is that something will have to change over time.