Initial Unemployment Claims Plunge to 262,000 - Lowest Since April 2000; What's Going On?

Initial unemployment claims plunged to 262,000 today bettering the Bloomberg Consensus.

The Fed is ready now to pull the trigger at anytime and today's jobless claims data may have their finger a little itchy. Initial claims, not skewed by special factors, plunged 34,000 in the April 25 week to 262,000 which is the lowest level since all the way back to April 2000. The 4-week average is down 1,250 to a 283,750 level which is just below a month-ago and points to improvement for the April employment report.

Continuing claims, where reporting lags by a week, are also at or near 15-year lows. In data for the April 18 week, continuing claims fell 74,000 to 2.253 million with the 4-week average down 18,000 to 2.291 million. The unemployment rate for insured workers is at 1.7 percent.

The Labor Department says there are no special factors in today's report though adjusting for weekly data surrounding Easter, which fell late in April last year, is always tricky. Still, on its face, today's report speaks to solid improvement in the labor market and to a big bounce back for the April employment report.

Initial Unemployment Claims



Initial Unemployment Claims 4 Week Moving Average



Initial claims are in the basket of leading indicators. Blue boxes show four occasions where claims turned up strong and no recession occurred. Red boxes show four occasions where claims turned up and a recession followed later. The purple boxes show two occasions where claims bottomed just as recession started.

I suspect the next turn higher, whenever it occurs, is likely to be significant. There will not be much of a warning. Other data suggests a recession may have already started.

Explaining the Low Numbers

Reader Tim pinged me with this thought on the numbers.

Hello Mish

We have talked of "job growth" under Obama and how a large number of part-time jobs were created that have led to people needing more than one part-time job to make ends meet. Of course, this is a two-edged sword. You lose one part-time job, and you cannot file for unemployment because you have another part-time job!

My daughter holds three part-time jobs totaling 43 hours and is categorized as "full-time" by the BLS because she works more than 32 hours a week.

One of those jobs just ended. She will drop to 28 hours total and be classified as part-time, with no unemployment eligibility. This is another hidden Obamacare impact, and a probable reason for the huge drop in unemployment filing.

Obamacare Effect

Tim refers to the classification of a full time job as 30 hours under Obamacare. In response, many fast food and retail stores slashed worker hours to 25 or less forcing those workers to take on second jobs. This inflates the strength of the job reports and the initial unemployment claims reports as well.

Because of all the multiple part-time jobs people hold, there may not be much of a jump in claims when the recession starts. It's possible there is no jump at all, just cutbacks in hours.

For discussion of the idea a recession may have already started, please see Real Q1 GDP 0.2% vs. Consensus 1.0%; Disaster in the Details.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Fed Cites Weather, "Transitory" Factors in FOMC Statement; No Hat Tricks; What About Consumer Sentiment?

Don't worry. The First Quarter GDP Disaster, released this morning is transitory.

How do I know? The Fed says so.

Here is the FOMC Statement from today. Emphasis mine.

Information received since the Federal Open Market Committee met in March suggests that economic growth slowed during the winter months, in part reflecting transitory factors. The pace of job gains moderated, and the unemployment rate remained steady. A range of labor market indicators suggests that underutilization of labor resources was little changed. Growth in household spending declined; households' real incomes rose strongly, partly reflecting earlier declines in energy prices, and consumer sentiment remains high. Business fixed investment softened, the recovery in the housing sector remained slow, and exports declined. Inflation continued to run below the Committee's longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Although growth in output and employment slowed during the first quarter, the Committee continues to expect that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to remain near its recent low level in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of declines in energy and import prices dissipate. The Committee continues to monitor inflation developments closely.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. 

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Jeffrey M. Lacker; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams.

No Hat Trick of Dissent

There were no dissents. My, how things change. At the December meeting there was a Rare Hat Trick of Dissent

But this time, the rationale for opposition changed. Dallas Fed leader Richard Fisher cast a no vote because he believes economic data suggests rate rises will need to come sooner than his colleagues currently expect. Philadelphia Fed chief Charles Plosser remains uncomfortable with language in the Fed statement that suggests the outlook for rate increases is to some degree driven by a calendar date, rather than by the economy’s performance.

Meanwhile, Narayana Kocherlakota of the Minneapolis Fed continues to believe it’s a mistake for the Fed to contemplate interest rate increases at a time when inflation is falling so far short of the central bank’s official 2% goal.

The breadth of the dissent ties up neatly with the challenging outlook for the monetary policy. The Fed has been greeted with an extended run of solid growth and hiring data that it broadly expects it to continue. At the same time, inflation remains persistently below the 2% price target central bankers say they will defend from both the high and low side. Put another way, one side of the outlook favors rate increases, while the other argues for sticking to an ultra-easy money stance.

Unanimously Transitory

If the Fed is unanimous, they all have to be right.

Right?

Consumer Sentiment Plunges

And what about that high consumer sentiment?

I am glad you asked, because the consumer confidence report came out yesterday and based on the FOMC statement today that "consumer sentiment remains high", it appears the Fed was not even watching.

The Bloomberg Consensus estimate for consumer confidence was 103. The range was 100.5 to 104. he actual index plunged to 95.2 from 101.3.

Consumer confidence has fallen back noticeably this month, down more than 6 points to a much lower-than-expected 95.2. This compares very poorly with the Econoday consensus for 103.0 and is even far below the Econoday low estimate of 100.5. The weakness, ominously, is the result of falling assessments of the jobs market, both the current jobs market and expectations for the future jobs market. The second quarter, which is expected to be much stronger than the weather-depressed first quarter, isn't likely to get off to a fast start, at least as far as this report goes.

The most striking weakness in April is the assessment of future conditions with the expectations component down 8.5 points to 87.5 for the weakest reading going all the way back to September. And the most striking weakness among the sub-components is employment, where fewer see more jobs opening up 6 months from now and more see fewer jobs available. This spills over into income where fewer see an increase ahead and more see a decrease.

But also weak is the present situation component which is down more than 2-1/2 points to 106.8 for its weakest reading since December. Here the most closely watched sub-component is the jobs-hard-to-get reading which is up nearly 1 full percentage point to 26.4 percent. This reading will hold back expectations at least to some degree for a big bounce back in the April employment report from a very weak March.

Inflation expectations are down sharply this month, 4 tenths lower to 4.8 percent which is one of the lowest readings of the recovery. Gas prices have been edging higher but are still low, the latter no doubt a major factor behind the latest reading.

Buying plans are mixed with automobile and vacation plans down but not home plans which are up. But home buying won't be a featured activity for consumers if their expectations for employment are weak. Today's report, showing weakness in the jobs assessment and in inflation expectations, won't be pulling forward expectations for the Federal Reserve's first rate hike.

Well, who cares if the Fed is watching consumer sentiment or not? Confidence is meaningless because weakness is unanimously transitory.

By the way, there were Only 560 Words In Today's FOMC Statement, Fewest Since October 2012, yet they could not even get the statement correct.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com 

Real Q1 GDP 0.2% vs. Consensus 1.0%; Disaster in the Details

The first quarter real GDP estimate of 0.2% was released today. In spite of all the extremely week economic reports lately, economists still could not figure out GDP was going to be near zero. The Bloomberg Consensus estimate was for 1.0%.



Note the lowest estimate was 0.2%. No one predicted negative. Who was it that predicted 2.4%? What planet is that person on?

So what else is there to do but blame the weather?

Heavy weather and the strong dollar took their toll on first-quarter GDP which, at only plus 0.2 percent, came in at the very low end of the Econoday consensus. This compares with an already soft fourth quarter which is unrevised at plus 2.2 percent.

Exports were the heaviest drag on the first quarter reflecting the strong dollar's effect on foreign demand. The heavy weather of the quarter contributed to an outright contraction in business spending (nonresidential fixed investment) and an abrupt slowing in consumer spending (personal consumption expenditures).

Price data, reflecting lower energy prices, are soft with the GDP price index at minus 0.1 percent vs the Econoday consensus for plus 0.5 percent. Prices were also soft in the fourth quarter at an unrevised plus 0.1 percent.

Details include an unwanted surge in inventories tied to lower demand and also possibly to shipment constraints tied to the quarter's West Coast port strike. Imports, likely limited by the port strike, did pull down GDP but to a much lesser extent than the prior quarter (imports are a subtraction in the GDP calculation).

Federal Reserve policy makers, in this afternoon's FOMC statement, may downplay first-quarter weakness as temporary. Nevertheless, the complete lack of punch underway in early second-quarter indicators, together with the softness of the fourth quarter when there were no special factors not to mention the lack of inflationary pressures in the economy, offer plenty of fuel for the doves at the Fed who want to hold off the first signals of a rate increase.

Exports

Gee, who could have predicted Exports would be the heaviest drag?

Let's take a January 31, 2015 flashback look: Diving Into the GDP Report - Some Ominous Trends - Yellen Yap - Decoupling or Not?

Exports added 0.37 percentage points to fourth quarter GDP. But note the trend. Because of the rising US dollar, export growth is dwindling. Will exports add or subtract to GDP next quarter?

I suggest the answer is subtract. Not only are US exports getting more expensive relative to Europe and Japan, the entire rest of the global economy is slowing rapidly. Our biggest trading partner is Canada and Canada is in recession, with a rapidly sinking loonie (Canadian dollar) on top of it. US Recession

The US won't decouple, just as China did not decouple from the global economy in 2008-2009 (a widely-held thesis I also knocked at the time).

Indeed, now that virtually no economist expects a US recession, I believe we are finally on the cusp of one, just as the Fed seems committed to hike.

GDP Details

Let's dive into the First Quarter 2015 (Advance Estimate) report for details.

The increase in real GDP in the first quarter primarily reflected positive contributions from personal consumption expenditures (PCE) and private inventory investment that were partly offset by negative contributions from exports, nonresidential fixed investment, and state and local government spending. Imports, which are a subtraction in the calculation of GDP, increased.

The deceleration in real GDP growth in the first quarter reflected a deceleration in PCE,
downturns in exports, in nonresidential fixed investment, and in state and local government spending, and a deceleration in residential fixed investment that were partly offset by a deceleration in imports and upturns in private inventory investment and in federal government spending.

The price index for gross domestic purchases, which measures prices paid by U.S. residents, decreased 1.5 percent in the first quarter, compared with a decrease of 0.1 percent in the fourth. Excluding food and energy prices, the price index for gross domestic purchases increased 0.3 percent, compared with an increase of 0.7 percent.

Real personal consumption expenditures increased 1.9 percent in the first quarter, compared with an increase of 4.4 percent in the fourth. Durable goods increased 1.1 percent, compared with an increase of 6.2 percent. Nondurable goods decreased 0.3 percent, in contrast to an increase of 4.1 percent. Services increased 2.8 percent, compared with an increase of 4.3 percent.

The change in real private inventories added 0.74 percentage point to the first-quarter change in real GDP after subtracting 0.10 percentage point from the fourth-quarter change. Private businesses increased inventories $110.3 billion in the first quarter, following increases of $80.0 billion in the fourth quarter and of $82.2 billion in the third.

Real final sales of domestic product -- GDP less change in private inventories -- decreased 0.5 percent in the first quarter, in contrast to an increase of 2.3 percent in the fourth.

Inventories, PCE, Negative Price Deflator
 
Over time, inventories trend to zero. So the fact that inventories added 0.74 to GDP is not a positive.

Personal consumption expenditures added 1.9% to GDP. Expect that to hold up?

Were it not for a highly questionable negative price deflator, first quarter GDP would have been negative.

With gasoline prices rising, there will be no miracle deflators next quarter.

If I can brag a bit, I nailed this back in January, and economists could not figure it out in spite of weak report after weak report for three more months!

The second estimate of Q1 GDP comes out on May 29. Any number of changes could send Q1 negative.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Costco vs. Walmart and Reader Responses Over Minimum Wage

I received lots of emails and blog comments to my article Reader Question: Is the Minimum Wage Really a Maximum Wage?

In regards to living wage Tesla responded ...

"You clearly have never run a business. if your employees are not able to live , or more importantly , just having living problems in general : they are 1) not going to work hard for you sometimes 2) might steal from you 3) might destroy your business property or otherwise not protect it from other thieves."

Quite frankly, that is ridiculous. If you are concerned your employees will steal from you or destroy your property, you should not hire them in the first place.

And if someone is worth more than the minimum wage and you are afraid they will go elsewhere, then you pay more than the minimum wage.

Look at McDonalds's or Walmart. Did they suffer massive theft or property destruction by employees?

Both recently raised their base pay scale. Why? Because they could not attract a good work force at the wage they were paying. This is how it should work, not by living wage nonsense. 

Carl responded ...

"Another important thing to remember about the minimum wage is that it removes from the workforce all those that are not worth the minimum wage. With a minimum wage, such persons automatically become government dependent."

Yep, exactly.

Ron ...

Reader Dave asks ...

"Hi,  Mish. Costco does pay more than Walmart as a big box business. It also gives employees all holidays off. How do they do it and WMT can't?"

The answer is Costco has a different model. It charges higher prices and its stores are generally in more upscale areas.

Walmart employs about 2.1 million.

Costco employs 192,000.

OK - let's have Walmart pay the same as Costco. To do it will compete in the same space as Costco so it will immediately fire 1.9 million people and close thousands of stores.

Happy with that outcome?
Perhaps not.

So let's just mandate $15.00 an hour higher benefits like Costco, across the board for every US company. Then let's watch another 4 million jobs vanish.

This is all so obvious that it's ridiculous to be even discussing. Yet here we are.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Richmond Fed Manufacturing Index Negative Second Month

The Fed manufacturing surveys continue to disappoint. Today, the Richmond Fed reading came in at -3 matching the lowest guess on Bloomberg.

The headline index is in the minus column for the second month in a row, at minus 3 vs March's minus 8. New orders are in the negative column for the 3rd month in a row, at minus 6, while backlog orders, at minus 8, continue to extend their long negative streak. Shipments are negative, at minus 6, and capacity utilization is negative, at minus 4.

Yet despite the weakness in orders and despite the weakness in shipments, employment in this report, as it curiously has been in other manufacturing reports as well, is up, to plus 7 vs plus 6 in March. This must reflect confidence that ongoing weakness is only temporary and that order and shipment momentum is certain to build.

Other details include depressed price readings, consistent with other reports as well. The manufacturing sector is being held down by weak exports and trouble in the oil & gas sector, but it's not keeping firms from hiring.

Misplaced Confidence?

The Richmond Fed reports Manufacturing Sector Activity Remained Soft; Employment and Wages Grew Mildly

Overall, manufacturing conditions remained soft in April. The composite index for manufacturing moved to a reading of -3 following last month’s reading of -8. The index for shipments and the index for new orders gained seven points in April, although both indicators finished at only -6. Manufacturing employment grew mildly this month. The indicator gained one point, ending at a reading of 7.

Manufacturers looked for better business conditions in the next six months. Survey participants expected faster growth in shipments and in the volume of new orders in the six months ahead. Producers also looked for increased capacity utilization and anticipated rising backlogs. Expectations were for somewhat longer vendor lead times.

Survey participants planned more hiring, along with moderate growth in wages and a pickup in the average workweek during the next six months.

It's important to note that a single firm hiring one person will counterbalance another firm firing 50. It's entirely possible employment is not as strong as it looks (not that 7 is a particularly strong number in the first pace).

Finally, I suspect confidence is on the high side looking ahead. Given strength in the US dollar and a clearly slowing China, I see no reason to believe there is going to be a big second quarter recovery, or if there is one, that it will last.

This isn't all due to the weather.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Deconstructing and Debunking Shadowstats

An interesting article came my way today courtesy of a friend "BC". The article is Deconstructing ShadowStats. Why is it so Loved by its Followers but Scorned by Economists? by Ed Dolan.

Mish readers likely know that I believe inflation to be understated, and that I also believe Williams' ShadowStats is wildly on the high side. For example, please consider GDP, Real GDP, and Shadowstats "Theater of the Absurd" GDP.

I have also mentioned food inflation on many occasions. While food prices (especially beef) did jump in the last year or so, I recently bought chicken breasts for $.99 a pound and very lean center cut pork chops for $2.49. Sale prices on center cut pork chops have generally ranged from $1.79 to $2.49 for 15 years! Not on sale, I have seen them as high as $5.49.

So I buy pork chops on sale, and freeze them. Same with chicken and beef. While non-sale prices have gone up more, ShadowStats calculations seem absurd.

Want to combat food inflation? Buy a big freezer, buy food on sale, and freeze it.

I never dove in into Williams' numbers to see where he may have gone wrong. Ed Dolan just did that, with convincing tables, graphs, and commentary.

Here is a snip.

A can of tomato sauce that cost $.25 at Piggly Wiggly in 1982 cost $.79 at my local market in early 2015. Starting from the 1982 price, the CPI predicts that it should cost $.61 in 2015 while ShadowStats predicts that it should cost $2.64. Starting from the 2015 price and working backwards, the CPI predicts that it should have cost $.32 in 1982 while ShadowStats predicts that is should have cost $.08. Based on these calculations, we see that the CPI underestimates inflation, as measured by the Tomato Sauce Index: The ratio of the 2015 predicted price of $.61 to the 2015 actual price, $.79, is .77, an underestimate of 23 percent. The ratio of the ShadowStats prediction to the actual price is 3.32, an overstatement of 223 percent. For tuna, both indexes overestimate inflation, the CPI by 34 percent and ShadowStats by 478 percent, and so on.



Has Williams Simply Made a Mistake?

The fact that the ShadowStats inflation rate fails every crosscheck makes one wonder whether Williams has simply made some kind of mistake in his calculations. I believe that he has done just that. The mistake, I think, can be found in a table given in a post that represents Williams’ most complete explanation of his methodology.

... Williams’ use of a running total of inflation differentials to compute a “cumulative inflation shortfall” of 5.1 percentage points exaggerates the true impact of the methodological changes made by the BLS. A better way to estimate the cumulative inflation shortfall would be to look at the differences between CPI-U-RS and CPI-U before 1983, the year when the BLS implemented the first of the changes that it incorporates in the CPI-U-RS series. That approach is not quite as precise when we use real-world numbers, as Williams does in his original table. As explained earlier, the actual data include statistical noise caused by changes in weighting and in relative price changes among sectors. However, we can approximate the true inflation shortfall by averaging the numbers for 1981 and 1982 from Williams’ table, giving an estimate of -0.45 percentage points.

As mentioned above, Williams’ ShadowStats inflation series incorporates an additional 2.0 percentage point correction to reflect methodological changes that are not captured in the CPI-U-RS series. I would like to examine that number more carefully in a future post, but for the sake of discussion, we can let it stand. If so, it appears to me that, based entirely on Williams’ own data, methods, and assumptions, the adjustment for the ShadowStats inflation series should be about 2.45 percentage points below CPI-U, rather than the 7 percentage points he uses.

In my view, Williams alternative measure of inflation would be more convincing if he were to make this correction. It would also be less likely to feed the anti-government paranoia of some of his followers, who allege that the BLS is falsifies source data and manipulates reported indicators in the way that Argentina and some other countries appear to do.

If you are a true believer in ShadowStats numbers, I suggest you read Dolan's article in entirety for a convincing rebuttal.

By the way, Dolan was quite polite in his rebuttal, concluding with "I would like to thank Williams for taking the time to make detailed comments on an earlier draft of this post. Our private dialog has not yet led to a complete resolution of the issues I have raised here, but I hope that he will address them in future public comments. The search for alternative inflation indicators goes on."

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Valuations: Maybe I am Crazy

Relative vs. Absolute Value

As I watch valuations on stocks soar higher and higher into the stratosphere, I keep asking "where is the value?"

The problem for most is confusing "relative" value vs. absolute value. Stocks may be "cheap vs. bonds" but what does that matter if bonds are ridiculously overpriced?

Fair Value Has Three Digits

John Hussman has an interesting post this week entitled Fair Value on the S&P 500 Has Three Digits.

The last time I quoted Hussman, a manager for a prominent investment firm emailed something on the lines of "Mish, please do yourself a favor and stop referring to Hussman".

Actually, that was likely be good advice. The problem I have with the advice is simple: I happen to agree with Hussman.

Right, wrong, or in between, I say what I believe. I do not say things I disagree with to get blog traffic up, investments up, or page hits up. I say what I believe, and I suspect it has cost me traffic. I upset Republicans and Democrats, equity bulls and bears, and US treasury bulls and bears.

Things are so crazy I have been accused of being a flaming Obama liberal as well as being in Bush's pocket. Truth be known, I never voted or Obama or Bush, and I have never missed voting in a national election since I was 18. Of course, some people think I am crazy to vote at all and that comment has come up when I mention that I vote.

Life would be so much simpler for me if I was obnoxiously one sided, if I never offended anyone ever, or if I purposely offended everyone all the time.

There's value in being universally despised, value in being hated by half the people all the time, or in never saying anything to offend anyone (being universally liked). Traffic-wise, those three models make perfect sense.

You can quote me on this: It's a tough business to annoy half the people half the time, when the half constantly switches.

Nonetheless, here we go again.

Value Investing: Is it Possible? What Does it Mean?

Please consider a few snips from Hussman. Emphasis in bold by Hussman.

Last week, the Nasdaq Composite finally clawed its way to breakeven, 15 years after its spectacular bubble peak in 2000. It’s a testament to the overvaluation of technology stocks in 2000 that it has required the third equity bubble in 15 years to reclaim that 2000 high, at least briefly.

Where is “fair value” today? We have to be careful here because the concept of “fair” depends on your assumptions about what a reasonable investment return should be. If I show you a security that’s expected to pay out $100 ten years from today, and I tell you that the current price is $82, you can quickly calculate that the expected return on that security is 2% annually – and you don’t need to know anything about interest rates to do that arithmetic. Interest rates come in after you do that arithmetic. Interest rates then matter only because they give you something to compare with that 2%. Now, if you decide that a 2% annual return over the coming decade is just fine with you, in view of competing alternatives, then it’s fine to call that security “fairly valued.” But even if you decide that the security is fairly valued, you should still expect a 2% annual return over the coming decade. If you viewed a 10-year return of 8% as reasonable, you’d peg “fair value” at $46.32.

On the basis of valuation measures best correlated with actual subsequent market returns, we can say with a strong degree of confidence that the S&P 500 would presently have to drop to the 940 level in order for investors to expect a historically normal 10-year total return of 10% annually. That 940 figure for the S&P 500 would not represent some extreme, catastrophic outcome. It’s not a level that would even represent undervaluation from a historical perspective. It’s the level that we would associate with average, historically run-of-the-mill long-term equity returns. As we observed at the 2000 peak, “if you understand values and market history, you know we’re not joking.”

Last month, Stan Druckenmiller recounted his own experience with capitulation and performance chasing when he was the lead portfolio manager for George Soros and the Quantum Fund:

“I’ll never forget it. January of 2000 I go into Soros’ office and I say I’m selling all the tech stocks, selling everything. This is crazy... Just kind of as I explained earlier, we’re going to step aside, wait for the next fat pitch. I didn’t fire the two gun slingers. They didn’t have enough money to really hurt the fund, but they started making 3 percent a day, and I’m out. It’s driving me nuts. I mean, their little account is like up 50% on the year. I think Quantum was up seven. It’s just sitting there.

“So like around March I could feel it coming. I just – I had to play. I couldn’t help myself. And three times during the same week I pick up a – don’t do it. Don’t do it. Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks, and in six weeks I had left Soros and I had lost $3 billion in that one play. You ask me what I learned. I didn’t learn anything. I already knew I wasn’t supposed to do that. I was just an emotional basket case and couldn’t help myself. So maybe I learned not to do it again, but I already knew that.”

Not Predictions

Please note that 940 is not a prediction by Hussman or by me. It is a value judgment. The S&P "fair value" number would be higher at an 8% discount and even higher at a 6% discount.

And regardless of the discount rate, stocks can overshoot or undershoot. Stocks can also go sideways for 8-10 years doing much of nothing. Japan is proof enough.

Please don't tell me "It cannot happen here". It can.

Pension plans would be destroyed if stocks go nowhere for 8 years. Moreover, I suspect the Fed would be  relatively pleased at such a benign outcome (assuming that was the only adverse outcome).

Where is Value?

Value is always in the eyes of the beholder. People saw value in dotcom companies in 2000, in housing in 2006, in gold in 1980, in Japan in 1990.

Today people see value in negative yield government bonds, in junk bonds that pay interest in debt, and in equities that have a smoothed valuation as high or higher than 1929, 2000, and 2007.

Maybe I am Crazy

I see value in gold and gold miners, in yen-hedged Japanese equities, and in Russian equities at a PE of 6 (see Readers ask "How Does One Invest in Russia?")

But hey, maybe I am crazy. Maybe we see government bonds trading at -5.0% yield and smoothed PEs at 35, topping valuations of 2000 and 1929.

Things are nearly always cheap "relative" to something else. There's a chance the "something else" of the future refers to peak valuations, not now, but rather in 2016.

Feelin' lucky?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com