Mish's Global Economic Trend Analysis

Hussman on Misallocating Resources, Market Valuations, Earnings Estimates, and Public Policy
Kentucky Retirees May Soon Outnumber Pension Contributors
Kelly Nguyen for Georgia District 5 - Atlanta
Bleak Outlook for Small Businesses and Job Creation; Where Obama Went Wrong, and What to do About It

Hussman on Misallocating Resources, Market Valuations, Earnings Estimates, and Public Policy

Posted: 12 Jul 2010 05:28 PM PDT

Once again John Hussman has written an excellent weekly column. This week, in Misallocating Resources, Hussman talks about stock market valuations, PE ratios, bailouts, and other things.

Let's start with a look at stock market valuations.

Market Valuations and Earnings Estimates

From Hussman...

On a valuation basis, the S&P 500 remains about 40% above historical norms on the basis of normalized earnings. The disparity between our valuation assessment and the putative undervaluation being touted by Wall Street analysts is so great that a few remarks are in order. First, virtually every assessment that "stocks are cheap" here is based on the ratio of the S&P 500 to year-ahead operating earnings estimates, and often comes with a comparison of the resulting "earnings yield" with the depressed 10-year Treasury yield. What's fascinating about this is that this is the same basis on which analysts deemed stocks to be about 40% undervalued just prior to the 2007 top, following which the market plunged by more than half. There's a great deal of analysis regarding forward operating earnings that I published in 2007, but probably the most comprehensive piece was Long Term Evidence on the Fed Model and Forward Operating P/E Ratios from August 20, 2007.

Optimism is Insane

I happened to mention similar thoughts last week in a Tech Ticker with Joe Weisenthal: Mish: Say No to Stocks, Because Optimism Is "Insane"

The optimism I mentioned was in relation to earnings estimates, not trader sentiment measures such as bull vs. bear measures.

Continuing with Hussman ...

When you hear analysts say that the historical average P/E ratio is about 15, you have to recognize that this is the normal P/E based on trailing 12-month earnings after subtracting all writeoffs and other charges. Forward operating earnings are invariably much higher, and it turns out that the comparable historical norm, as I discuss in that 2007 piece, is only about 12. If you exclude the late 1990's bubble valuations, you get a historical norm closer to 11.5. The 1982 and 1974 market lows occurred at about 6 times estimated forward operating earnings.

A final observation is crucial. Current forward operating earnings estimates assume profit margins for the S&P 500 companies that are nearly 50% above their long-term historical norms. While we did observe such profit margins for a brief shining moment in 2007, profit margins are extraordinarily cyclical. Investors will walk themselves over a cliff if they price stocks as if profit margins, going forward, will be dramatically and sustainably higher than U.S. companies achieved in all of market history.

Bill Hester provides more insight on Wall Street earnings projections in his latest research piece Wall Street Earnings Expectations Ignore Economic Divergences

Now switching to Bill Hester ...

From the link immediately above

This week brings the official start to second-quarter earnings announcements. As the mechanism for data delivery gets switched from the faucet to the fire hose, investors may want to keep a few things in mind as the reporting season progresses. Lofty earnings expectations result in poor stock market performance, on average.

The chart below gives one perspective into how bullish stock analysts currently are. The data is compiled by Ned Davis and it shows the median estimated one-year earnings growth rate for the companies in the S&P 500. Analysts are now forecasting more than 21 percent earnings growth for the median stock over the next year, a record level in the 30 years of data.

As John Hussman noted in Recession Warning, three of the four metrics that provided a warning of an approaching recession in 2007 are in place.

A drop in the PMI index to 54 or below is the remaining indicator in that original set of metrics that hasn't signaled.

The chart shows the growing divergence between expectations for earnings and the global PMI indexes.

The spread between the changes in global PMI Indexes and global earnings expectations is an increasing concern, especially considering the evidence that increases the probability of renewed economic weakness. Earnings growth forecasts have never been higher measured by the median expectation. This alone, typically leads to poor stock performance. The growing gap between PMI Indexes and earnings expectations increases these potential risks.

Hester has 5 charts in total so please give the article a closer look.

Commenting on Public Policy

I like to comment on public policy although some wish me to stick with the economy. The problem is, someone has to stand up to Krugman, Geithner, Summers, Bernanke, and others who want to do nothing more than throw money at every problem.

Hussman seems to feel the same way. From the first link ...

Misallocating resources

There is little question that we have, for more than a decade, squandered our productive resources in the pursuit of bubbles. Almost unbelievably, real private gross domestic investment is lower today than it was 12 years ago, and much of the gross domestic investment that we have made in the interim has been destroyed in mispriced speculative activity such as residential construction and commercial real estate development.

If our only response to excess consumption is to pull out all the stops trying to "stimulate" consumption every time it falters; if our only response to reckless lending is to defend the bondholders every time their poor allocation of capital threatens to produce a loss for them, then quite simply, we will destroy our economy, our future, and our standard of living. The last thing I want to be is a cheerleader for the bears here. But quite honestly, it's difficult to envision a return to long-term saving, productive investment, and thoughtful allocation of capital until - as happens every two or three decades - the speculative elements of Wall Street are crushed to powder.

With regard to education, my impression is that the educational sector in the U.S. is about as inflexible the European labor market - the entire structure is hugely inefficient because it is detached from measures of quality and student time-on-task, undercompensating many excellent teachers and at the same time institutionalizing the employment of poor ones. Meanwhile, the failure of parents to maintain a heavy involvement in their kids' education, in the belief that the responsibility for education, personal responsibility and moral development can simply be thrust onto teachers, is a problem that money alone can't address.

If we as a nation fail to allow market discipline, to create incentives for research and development, to discourage speculative bubbles, to accumulate productive capital, and to maintain adequate educational achievement and human capital, the real wages of U.S. workers will slide toward those of developing economies. The real income of a nation is identical its real output - one cannot grow independent of the other.

Those who understand economics and have a strong opinion on public policy need to state it. I appreciate the fact that Hussman is willing to do so.

The Fed of course sees things differently. In "Economics is Hard. Don't Let Bloggers Tell You Otherwise" the Fed says bloggers have nothing to add to the economic debate.

This self-serving statement means that the only people qualified to talk on the economy are the very same dunces who were wrong about everything, every step of the way.

Key Points

Sharply rising earnings estimates do not match the fundamentals
It is easy to get sucked into believing "stocks are cheap" by focusing on wildly optimistic forward earnings estimates.
Stimulating consumption when the problem is debt cannot possibly work, something I said last week in a Tech Ticker segment "Stimulus Will Fail Like it Always Does"
We have squandered our real wealth in pursuit of bubbles, while bailing out those most responsible

I just touched on those points above, inquiring minds will want to give Hussman's and Hester's articles a closer look.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Kentucky Retirees May Soon Outnumber Pension Contributors

Posted: 12 Jul 2010 02:27 PM PDT

In attempting to reduce current payouts, Kentucky granted excess benefits to workers who would go on early retirement. The result was less than stellar.

Please consider Retirees may soon outnumber workers contributing to state pension system

Just four years ago, there were 51,027 state workers contributing toward the pension fund and 34,120 retirees drawing benefits from it. By 2009, the number of workers slipped to 50,394 while the number of retirees leapt 19 percent to 40,531.

(In a separate fund for Kentucky State Police workers, there already are 239 more retirees getting pensions than active troopers on duty. County governments, served by a third fund, had 93,481 workers and 45,564 retirees.)

At the same time, benefits got a little richer for workers who left under the "incentive windows" the legislature created in recent years to encourage retirement and reduce the payroll. One such incentive let workers base their pensions on their best three years of salaries rather than their best five years.

These incentives cause headaches at the Kentucky Retirement Systems because they send droves of workers for the exit years earlier than expected, Burnside said. That produces more people taking money from the funds, fewer people giving money and less money to invest for gains, he said.

Most state employees hired before 2008 can retire after 27 years and collect a pension based on an average of their best-paid years of service. For instance, a worker who earned $50,000 a year would draw an annual pension of $27,000 for the rest of her life, plus cost of living increases. Workers who perform "hazardous duty," such as police officers, can retire after 20 years.

In the private sector, only about one in five workers still have a "defined-benefits" pension that guarantees payments for life, according to the U.S. Bureau of Labor Statistics.

The Kentucky Chamber of Commerce has used its Frankfort lobbying clout in recent years to call for a less generous public retirement package, in part because the costs help to starve other priorities, such as education.

"Clearly the state has tremendous financial problems now and we need to find ways to address this situation," said Dave Adkisson, chamber president.

Adkisson challenges the notion that government employees deserve better retirement benefits as compensation for salaries that are smaller than the private sector's. Based on the most recent data, Adkisson said, the average Kentucky state employee gets $40,900 a year, compared to $34,950 a year for the average private employee in Kentucky.

Once again, the first thing to do is stop digging deeper holes.

Defined benefit pension plans need to be stopped immediately for new hires. Second, as many public union jobs a possible (in theory all of them) should be privatized.

Finally, existing benefit promises need to be look at from every angle to see what can be done. Cities and counties can go bankrupt, but states can't.

The ultimate solution for states is simple: default.

Public Pension Plans are like Rotting Whales

Every day, union supporters send me emails whining about these kind of posts. One person proposed I was "ignoring whales" while focusing on minnows.

Here is the deal, public unions along with corrupt politicians have bankrupted nearly every state in the union. This is one of the biggest issues facing the US, if not the biggest issue.

Yes, we bailed out the banks, but no one railed against that more than I did. The battle was lost. The new battle is for fiscal sanity. It makes no sense to fight battles that are over. We cannot undo the bank bailouts. We can do something about public unions and public union greed.

Public unions and untenable pension problems are the whales in the living room. It is high time we do something about it because the whales are rotting and the stench is unbearable.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Kelly Nguyen for Georgia District 5 - Atlanta

Posted: 12 Jul 2010 10:39 AM PDT

I have a few more candidates that I would like you to consider supporting in the upcoming mid-term elections. The first of these candidates is Kelly Nguyen running in Georgia's 5th Congressional District.

Please check out Kelly Nguyen Stands on Issues.

Jobs and the Economy: Small businesses are the backbone of the American economy and employ over half of all Americans. The recession was inevitable because of federal policies working against small businesses. We must reverse federal policies to save small businesses, even though special interests are against it.

Bailouts: It is futile to hope bailouts can save us from an economic crisis. The federal government should not burden taxpayers by bailing out irresponsible banks and failed corporations. When small businesses fail, the federal government does not swoop in to save them, and it should not be any different with banking and big business. There is no such thing as "too big to fail."

Size and Scope of Government: When government takes half the wealth from the people, dictates what individuals can and cannot do in their personal lives, and spends trillions of dollars it does not have, government is too big. To lower taxes, we must downsize the federal government. Downsizing the federal government should be first on the agenda, then reducing and eliminating income taxes.

Kelly Nguyen Writes ...

Hello Mish,

I am running for Congress in GA's 5th Congressional District. I've lived in Atlanta for 17 years, where I work as a self-employed contractor in graphic design and web development. Before becoming self-employed, I managed various small businesses for several years.

My main motivation behind running for Congress is the disenfranchisement I have experienced dealing with federal/state regulations and over-taxation.

I believe government policing of small businesses has been a major contributing factor in the U.S. economic crisis, along with market manipulations caused by the federal reserve, and a non-humble, empirical foreign policy. I am a Ron Paul Republican.

In Liberty,
Kelly Nguyen

It is not often voters get a chance to elect a candidate of the quality of a Ron Paul or Kelly Nguyen.

Please do what you can to Support Kelly Nguyen. Please click on the link and donate to the Money Bomb for Kelly.

If you wish to volunteer time, please Contact Kelly Nguyen. Every vote matters!

It's long overdue we elect Congressional representatives who will uphold the constitution, are fiscally conservative, and genuinely want to do something about bureaucratic waste and massive government spending.

I am very optimistic about Kelly Nguyen's chances, but you have to help. Please make a contribution of time or money.

Primary Tuesday, July 20th!
If you want to lower your taxes, please vote Kelly Nguyen!
Contact your neighbors and have them do the same.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Bleak Outlook for Small Businesses and Job Creation; Where Obama Went Wrong, and What to do About It

Posted: 12 Jul 2010 03:17 AM PDT

There will be no recovery without jobs, and there will be no net job creation if small businesses, especially startups, do not lead the way.

Please consider The Importance of Startups in Job Creation and Job Destruction by Tim Kane, PhD, and Senior Fellow in Research and Policy at the Kauffman Foundation.

A relatively new dataset from the U.S. government called Business Dynamics Statistics (BDS) confirms that startups aren't everything when it comes to job growth. They're the only thing.

Put simply, this paper shows that without startups, there would be no net job growth in the U.S. economy. This fact is true on average, but also is true for all but seven years for which the United States has data going back to 1977.

Figure 1 presents summary data from the BDS,1 showing that firms in their first year of existence add an average of 3 million jobs per year. By construction, the BDS defines an existing firm—age one up to age twenty-six and beyond—such that it can both create and lose jobs. In contrast, a startup, or age zero firm, only creates jobs because it experiences no gross job destruction. We might anticipate that the net job gain also would be positive at existing firms, but that is decisively not the case during most years on record. Notably, the figure shows that, during recessionary years, job creation at startups remains stable, while net job losses at existing firms are highly sensitive to the business cycle.

On balance, existing firms lose more jobs than they create. But once Deaths are set aside, Survivors usually create more net jobs than startups do. Among Survivors, so-called gazelle firms are certainly more important still.

In sum, the new firm-level summary data in Figure 1 reveal that startup firms are responsible for all net job creation during most years, while existing firms (aged one year and older) are usually net job losers. To be fair, startups have a definitional advantage because they can't lose jobs, and some of their created jobs will surely be lost by next year's age one firms.

What Figure 1 doesn't reveal then is the gross flows within the firm age categories, which is the inspiration for this study. We would like to know whether age one firms are net job creators. Ideally, we would like to pinpoint the transition year when firms become net job destroyers, or find if a consistent pattern even exists. ...

[Figure 4] paints a picture surprisingly different from what informed, conventional wisdom presumably imagines.

Analysis

Startups create an average of 3 million new jobs annually. All other ages of firms, including companies in their first full years of existence up to firms established two centuries ago, are net job destroyers, losing 1 million jobs net combined per year. Patterns of job growth at startups and existing firms are both pro-cyclical, although existing firms have much more cyclical variance.

The implication of this finding could, and perhaps should, shift the standard employment policy paradigm. Policymakers tend to reflect common media stereotypes about job changes in the economy, which is to say a focus on the very large aggregate picture (such as the national or state unemployment rate) or on news of very large layoffs by individual companies. That attention is almost certainly misplaced.

Nationwide measures are a blunt tool for analysis, and net employment growth reveals little that policy can affect.

Similarly, the common zero-sum attempts to incentivize firm relocation are oblivious to the important pattern of gross job creation revealed by the BDS. States and cities with job creation policies aimed at luring larger, older employers can't help but fail, not just because they are zero-sum, but because they are not based in realistic models of employment growth.

Job growth is driven, essentially entirely, by startup firms that develop organically. To be sure, Survivors create zero to 7 million net jobs (half of which are at establishment births), while Deaths account for a net loss of 4 million to 8 million jobs, which are large flows for the context of the steady job creation of 3 million startup jobs. But, in terms of the life cycle of job growth, policymakers should appreciate the astoundingly large effect of job creation in the first year of a firm's life. In other words, the BDS indicates that effective policy to promote employment growth must include a central consideration for startup firms.

Current Jobs Picture

The official unemployment rate is 9.5%. However, that number does not include 2.6 million "marginally attached" workers who wanted a job but were not counted as unemployed because they had not searched for work in the last 4 weeks.

It also does not include students who stay in school piling on debt because they cannot find a job, and it does not include people working part time who want to work full time.

More realistic measurements incorporating those things show that unemployment is closer to 17% than 9.5%.

Unfortunately, things are not improving. Let's take a look at the conditions, then the reasons why.

Bleak Outlook For Small Businesses

Please consider Jobs outlook for small businesses may be getting bleaker.

For the recovery to gain steam, most economists believe small businesses need to be strong enough to hire new workers. But according to one measure, the employment picture in this sector is weakening.

Intuit Inc., which provides payroll services for small employers, says the nation's tiniest companies had fewer new hires last month than any time since October.

The slowdown in hiring is particularly troublesome, experts say, because small businesses typically hire first during a recovery. A reluctance by little companies to add positions could mean that the big firms, which typically lag behind, will add jobs even more gradually.

To calculate its estimate of national hiring, Intuit uses payroll information from its 56,000 small-business customers. The company defines small businesses as those with fewer than 20 employees.

Intuit's data show that small businesses hired just 18,000 additional workers last month. That's still positive territory, but it's less than a third of the 60,000 that were added in February, when it seemed that an employment recovery was imminent. Additional hiring dropped steadily during the spring, to 40,000 in April and 32,000 in May. Another payroll company, Automatic Data Processing Inc., painted an even gloomier picture, saying that small businesses lost 1,000 jobs nationwide in June.

"It's disappointing," Woodward said. "Considering how many unemployed people there are, it's disheartening."

To understand the oversized importance of these little businesses to the U.S. jobs picture, consider that the smallest firms — those with fewer than 20 employees — employ more than one-sixth of the nation's workers. But so far this year, these companies have provided about one-third of all new private-sector jobs, said Brian Headd, an economist with the Small Business Administration. So any cutbacks would be felt disproportionately throughout the economy.

"Small-business hiring is right at the heart of it because small businesses usually are the engine of job creation in the U.S.," said John Challenger, president of the employment consulting firm Challenger, Gray & Christmas. "It's small businesses that drive the unemployment rate down, and if the small businesses are faltering, that suggests that the risks of recession are growing."

Failed Policy

Those two articles highlight where and how Obama is going wrong.

Specifically, Obama is focused on "saving jobs" rather than creating a business environment that fosters the creation of new jobs and new businesses.

Administration policies waste money with makeshift projects such as repaving roads that do not need to be paved
Administration policies waste money protecting the jobs of overpaid bureaucrats and public union workers.
Administration policies, especially healthcare, have added to small business startup costs
Administration policies have raised taxes increasing the risk (lessening the risk-reward scenario to start a new business)

Business Profits - the Catalyst for Starting a Business

Why start a business? Profits of course! Yet, if government makes it too difficult to make profits, then ... Why start a business?

Please consider the following email from Robert J. Kecseg at Las Colinas Capital Management.

Hello Mish

Business profit is the real catalyst for new jobs. That is why tax reduction works so well. Lower taxes help businesses make profits. More profit means more capital investment and more innovation.

Reduced taxes across the board gives everyone an equal chance. In contrast, targeted government spending is always poorly allocated.

This is where people like Krugman have it all wrong. Please emphasize the power of profits.

Robert J. Kecseg
Las Colinas Capital Management,

Folly of Targeting Jobs

Thanks Robert.

Targeting jobs, is exactly what I railed about in Obama Hails New Solar Energy Jobs at Taxpayer Price Tag of $1,333,333 Each

Interestingly, I received several emails demanding I issue a retraction because Obama made loans not grants. So what? Those businesses may fail and if they do, taxpayers will be on the hook.

The key point however, is government ought not be picking winners and losers. Providing money to Abengoa Solar and Abound Solar Manufacturing may mean the failure of competing, perhaps even better businesses.

Certainly, the government's track record at picking winners and targeting stimulus is pretty miserable. Ethanol from corn, and various housing proposals that have all failed are good examples.

Corporate Tax Policy Encourages Jobs Flight

US tax policy allows deferral of corporate profits on taxes overseas. Tat policy practically begs large multinational to move jobs overseas and to keep profits there as well. Moreover, the policy gives unfair advantage to large corporations which can shelter profits vs. small corporations and startups that cannot.

President Obama cannot be blamed for this given the policy has been in place for years. Yet, no one seems inclined to want to do anything about it.

One common complaint I hear is "the Bush tax cuts did not create a lot of jobs". Fair enough, I certainly agree. Moreover, I have absolutely no love for President Bush. That said, one reason the Bush tax cuts did not work is Bush wasted trillions of dollars in Iraq and other war-mongering policies. That negated some of the benefits of lower taxes. Another reason is President Bush inherited an economic mess caused by the Greenspan Fed.

Obama inherited the same economic mess of course, but has also made matters worse by inept policies that have cost jobs and will continue to cost jobs.

How to Create Jobs

Slash corporate income taxes.
Scrap Davis Bacon and prevailing wage laws. Please see Thoughts on the Davis Bacon Act for more on the insanity of prevailing wage laws.
Privatize jobs held by public unions. Firing Public Union Workers Creates Jobs.
Require competitive non-union bidding on all projects involving Federal funds.
Legalize hemp for use in bio-fuels and clothing.
Kill crop subsidies
Allow drug imports from Canada
Simplify the tax code
Open up medical insurance across state lines
Stop attempting to be the world's policeman

Those are 10 easy things we can do that will foster job creation over the long haul (directly in some cases, indirectly in others buy putting more money in people's pockets). In general, government needs to get the hell out of the way and reduce taxes so people and businesses have more money to spend.

Instead, the Obama administration supports higher taxes, more government, and the status quo on existing overpaid public union workers. Is it any wonder the outlook for small business and startup hiring is bleak?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Monday, July 12, 2010

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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