Mish's Global Economic Trend Analysis

Reflections on Complacency, Valuations, Bear Market Troughs, Patience
Obama to Close "Skills Gap"; Where? How? Why is the Middle Class Shrinking? Living Wages
Rise of Intelligent Machines Will Open "Pandora's Box" Threatening Human Extinction

Reflections on Complacency, Valuations, Bear Market Troughs, Patience

Posted: 27 Nov 2012 11:31 PM PST

Inquiring minds are reading John Hussman's article on Overlooking Overvaluation.

Our estimates of prospective stock market return/risk, on a blended horizon from 2-weeks to 18-months, remains among the most negative that we've observed in a century of market data.

On the valuation front, Wall Street has been lulled into complacency by record profit margins born of extreme fiscal deficits and depressed savings rates. Profits as a share of GDP are presently about 70% of their historical norm, and profit margins have historically been highly sensitive to cyclical fluctuations. So the seemingly benign ratio of "price to forward operating earnings" is benign only because those forward operating earnings are far out of line with what could reasonably expected on a sustained long-term basis.

On the basis of smooth fundamentals such as revenues, book values, dividends and cyclically-adjusted earnings, the S&P 500 is somewhere between 40-70% above pre-bubble valuation norms, depending on the measure. That's about the same point they reached at the beginning of the 1965-1982 secular bear period, as well as the 1987 peak. Stocks are far less overvalued than they were in the late-1990's, but it is worth noting that nearly 14 years of poor market returns have resulted simply from the retreat from those bubble valuations to the current rich valuations. If presently rich valuations were to retreat again to undervalued levels that have accompanied the start of secular bull markets (see 1982 for example), stocks would produce yet another extended period of dismal returns. That prospect certainly isn't the reason for our present defensiveness, but it's worth understanding the dynamic that has produced the pattern of market returns we've observed over time.

At present, the return of the S&P 500 over the past decade – though below average – has actually overshot what would have been expected in 2002. This reflects the fact that valuations today are still well above their norms. Unless we assume that valuations will remain rich forever, this doesn't portend well for returns going forward.

We remain convinced that stocks are richly valued here. A fairly run-of-the-mill normalization of valuations in the course of the present market cycle would imply bear market losses of about one-third of the market's value, without even establishing significant undervaluation. Then again, there's no assurance that valuations will normalize, or that stocks will experience a bear market here. Maybe Wall Street is correct that profit margins will remain forever elevated and The New Global Economy™ will never again witness "normal" valuations on these measures at all. There's no shortage of analysts who effectively embrace that view by focusing only on forward-operating earnings.

Not Different This Time

Hussman's message has been the same for quite some time. I am in the same camp.

For now, the market has other ideas. Yet, to bet on a sustained market advance, one has to believe "It's different this time".

I do not believe it will be different this time, although (and as we have seen), market valuations can remain in the stratosphere for lengthy periods of time. However, in such instances the market will eventually take back excess gains as it did in 2000-2001 and again in 2008 through the first quarter of 2009.

What If?

Hussman wrote "If presently rich valuations were to retreat again to undervalued levels that have accompanied the start of secular bull markets, stocks would produce yet another extended period of dismal returns."

I've thought about this quite a bit over the past year, and I fail to see a way the stock market does not return to low valuations seen at the end of previous long-term bear markets. Demographics, debt levels, and reversion-to-mean tendencies simply will not support the rosy scenarios of growth most advisors assume.

If so, that means a 10-year P/E at or below 10, possibly for a number of years. The impact for boomers and on pension plans will be stunningly negative.

No Hiding Places

Up to this point, the real loss from stocks could have been compensated by one's allocation to bonds. However, from this point forward, with the 10-year treasury yield at 1.65% and pension plan assumptions at 8%, it's highly likely both stocks and bonds will be a drag on a 50/50 portfolio's real return, and especially on expected (needed) rates-of-return.

This reversion-to-the-mean, slow-growth dynamic, as it unfolds, seems likely to usher in the final exodus from "investing" by the boomers. It will also leave a scar on the those in their 20's and 30's today, which will keep them out of the markets for some time.

Need For Patience

I honestly believe the only investors, even professionals, who will make it through this exodus intact will be those who are able to hold some real assets and cash, and have the patience to wait, with the 'patience' part being the most critical.

There will be plenty of opportunities to buy into the stock market for a cyclical rallies, but most investors who try to trade will end up losing money because few have the patience to wait for good opportunities, while others will throw in the towel at precisely the wrong times.

That's life in a secular bear market, and few understand bear market dynamics. Fewer still actually realize how stacked the odds are against a sustained advance and why that is precisely so.

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

John Hussman is one of the speakers at my "Wine Country" Economic Conference on April 5, 2013. Click on Image to Learn More

Obama to Close "Skills Gap"; Where? How? Why is the Middle Class Shrinking? Living Wages

Posted: 27 Nov 2012 12:55 PM PST

President Obama says there is a "skills gap". A quick search says that many misguided souls believe the president.
For example Forbes writer Rich Karlgaard says The Skills Gap Exists.

Karlgaard believes the "gap is sure to grow as the population ages and industries from health care to manufacturing are altered by technology. Outsourcing to China won't be the answer, either. Its population is aging the fastest of all the major economies."

Vicki Needham writing for The Hill says Skills gap is hampering labor market.

Needham, citing a report by Deloitte says "job creation in the United States is hampered by a lack of highly skilled and adaptable workers whose talents don't match current job openings".

The Atlantic comments on Solving the Manufacturing Skills Gap.

Eighty percent of the manufacturing companies in the United States say they cannot find enough workers with the proper skills to fill open positions at their facilities. That's the number President Barack Obama cited, as he announced the Military-to-Civilian Skills Certification Program, in June 2012.

"If you can maintain the most advanced weapons in the world, if you're an electrician on a Navy ship, well, you can manufacture the next generation of advanced technology in our factories like this one," Obama said, speaking from the floor of a Honeywell plant in Minnesota.

But the problem is that veterans have had trouble getting hired, as Obama said, "simply because they don't have the civilian licenses or certifications that a lot of companies require."

Skills Don't Pay the Bills

The above columnists express widely believed economic hooey.

In contrast, Adam Davidson, in his New York Times column, Skills Don't Pay the Bills, precisely summarizes the problem in four deep thoughts.

Deep Thoughts

There is no skills gap.
Who will operate a highly sophisticated machine for $10 an hour?
Not a lot of people.
As a result, there is going to be a skills gap.

Davidson visited the engineering technology program at Queensborough Community College in New York City led by instructor Joseph Goldenberg whose manufacturing classroom consisted of "nothing but computers".

With that introduction, inquiring minds tune in a bit closer to some snips from Davidson.

Nearly six million factory jobs, almost a third of the entire manufacturing industry, have disappeared since 2000. And while many of these jobs were lost to competition with low-wage countries, even more vanished because of computer-driven machinery that can do the work of 10, or in some cases, 100 workers. Those jobs are not coming back, but many believe that the industry's future (and, to some extent, the future of the American economy) lies in training a new generation for highly skilled manufacturing jobs — the ones that require people who know how to run the computer that runs the machine.

Running these machines requires a basic understanding of metallurgy, physics, chemistry, pneumatics, electrical wiring and computer code. It also requires a worker with the ability to figure out what's going on when the machine isn't working properly. And aspiring workers often need to spend a considerable amount of time and money taking classes like Goldenberg's to even be considered. Every one of Goldenberg's students, he says, will probably have a job for as long as he or she wants one.

And yet, even as classes like Goldenberg's are filled to capacity all over America, hundreds of thousands of U.S. factories are starving for skilled workers. Throughout the campaign, President Obama lamented the so-called skills gap and referenced a study claiming that nearly 80 percent of manufacturers have jobs they can't fill. Mitt Romney made similar claims. The National Association of Manufacturers estimates that there are roughly 600,000 jobs available for whoever has the right set of advanced skills.

The secret behind this skills gap is that it's not a skills gap at all. I spoke to several other factory managers who also confessed that they had a hard time recruiting in-demand workers for $10-an-hour jobs. "It's hard not to break out laughing," says Mark Price, a labor economist at the Keystone Research Center, referring to manufacturers complaining about the shortage of skilled workers. "If there's a skill shortage, there has to be rises in wages," he says. "It's basic economics." After all, according to supply and demand, a shortage of workers with valuable skills should push wages up. Yet according to the Bureau of Labor Statistics, the number of skilled jobs has fallen and so have their wages.

Goldenberg, who has taught for more than 20 years, is already seeing it up close. Few of his top students want to work in factories for current wages.

It's easy to understand every perspective in this drama. Manufacturers, who face increasing competition from low-wage countries, feel they can't afford to pay higher wages. Potential workers choose more promising career paths. "It's individually rational," says Howard Wial, an economist at the Brookings Institution who specializes in manufacturing employment.

Situation in a Nutshell

Companies cannot afford to pay so much that they lose money.
Companies would rather invest in technology and robots to reduce the need for labor, than to pay workers more money
A shift manager at McDonald's can make $14 an hour, comparable to what manufacturing jobs pay
Union wages and benefits are a major problem

High Cost of Education

The problem is actually quite a bit deeper. Given the preposterously high cost of education in the US, students graduate from college with an expectation they need to make more than they can to pay off student debt.

The same holds true (and even more so) for those going back to school as well as those attending for profit colleges such as the University of Phoenix.

Here are a few eye openers:

Education Bubble: Student Loan Debt Passes Credit Card Debt, Expected to Hit $1 Trillion

Debt for Diploma Schemes: Debt for Diploma Schemes and the Cookie Monster Principle

Off-Balance-Sheet Budget Fraud: Budget Deficit Accounting Fraud and the Off-Balance-Sheet Student Loan Scam; Time to Scrap Entire Student Loan Program

Pell Grant Debt Zombies: For Profit Schools Turn Students Into Debt Zombies; It's Time To Kill The Entire Pell Grant Program

Buried in Debt: Subprime Goes to College; Students Buried in Debt; Who is to Blame?

Living Wage Nonsense

Keynesian and Monetarist clowns conclude that wages are not high enough. The masses lament for "living wages".

The problem is not that wages are too low, but rather costs are too high. Ben Bernanke, president Obama, union sympathizers and other misguided fools seek to drive wages up.

The results are what any rational person should expect: loss of jobs to Asia, loss of jobs to technology, prices rising faster than wages, and overall debt soaring to the moon.

Reflections on Affordable Housing, Education, Medicine

There are hundreds of "affordable housing" programs. Every damn one of them drove costs higher by artificially creating demand right up until the pool of greater fools ran out. Then, as soon as housing crashed, government and the Fed made a concerted effort to drive back up prices.

In effect, no one really wanted affordable housing. Rather they all wanted "affordable housing slush funds".

The same holds true for education and health care.

Why is the Middle Class Shrinking?

The simple fact of the matter is there is absolutely nothing wrong with falling prices. Indeed the average guy on the street would welcome falling prices. The Fed, however, says no.

The first result of Fed policy (coupled of course with Fractional Reserve Lending) is rising prices of essential goods and services coupled with falling real wages.

The second result of Fed policy was a real estate and financial asset crash.

The third result of Fed policy is reduced demand for credit (which constitutes deflation in my book).

Since the Fed never learns, we have seen reckless rounds of QE following reckless rounds of QE hoping to stimulate jobs and lending. Yet, people actually wonder "Why the middle class is shrinking"

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

"Wine Country" Economic Conference Hosted By Mish
Click on Image to Learn More

Rise of Intelligent Machines Will Open "Pandora's Box" Threatening Human Extinction

Posted: 27 Nov 2012 10:00 AM PST

As robots keep replacing human workers in manufacturing and now retail and food servicing, fears have arisen that artificial general intelligence (AGI) machines will threaten mankind when "intelligence escapes the constraints of biology" and machines can design and create their own offspring.

If that idea sounds far-fetched, then please consider Cambridge boffins fear 'Pandora's Unboxing' and RISE of the MACHINES.

Boffins at Cambridge University want to set up a new centre to determine what humankind will do when ultra-intelligent machines like the Terminator or HAL pose "extinction-level" risks to our species.

A philosopher, a scientist and a software engineer are proposing the creation of a Centre for the Study of Existential Risk (CSER) to analyse the ultimate risks to the future of mankind - including bio- and nanotech, extreme climate change, nuclear war and artificial intelligence.

Apart from the frequent portrayal of evil - or just misguidedly deadly - AI in science fiction, actual real scientists have also theorised that super-intelligent machines could be a danger to the human race.

Jaan Tallinn, the former software engineer who was one of the founders of Skype, has campaigned for serious discussion of the ethical and safety aspects of artificial general intelligence (AGI).

Tallinn has said that he sometimes feels he is more likely to die from an AI accident than from cancer or heart disease, CSER co-founder and philosopher Huw Price said.

Humankind's progress is now marked less by evolutionary processes and more by technological progress, which allows people to live longer, accomplish tasks more quickly and destroy more or less at will.

Both Price and Tallinn said they believe the rising curve of computing complexity will eventually lead to AGI, and that the critical turning point after that will come when the AGI is able to write the computer programs and create the tech to develop its own offspring.

"We need to take seriously the possibility that there might be a 'Pandora's box' moment with AGI that, if missed, could be disastrous. With so much at stake, we need to do a better job of understanding the risks of potentially catastrophic technologies." said Price.

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

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Tuesday, November 27, 2012

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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