Monthly Archives: July 2018

Less than 1 year to the crash

Stock market crashes happen for a reason, and generally the reason is that owning stock is seen as less profitable than owning bonds, gold, guns, or hundred-dollar bills stuffed into one’s mattress. For this essay, I thought I might explain the reasoning behind the alarm bells that virtually every economist has been sounding. For the last year and a half they’ve been sure a severe correction is imminent. The reason has to do with price and predictions of profitability.

Let’s begin with Nobel Laureate economist, Paul Krugman of the New York Times. He has been predicting severe job losses, and a permanent stock collapse since Trump’s election in November 2016. Virtually every week he announces that the end is near, and every month the economy looked better. A lesser man would give up, but he has not. Why? Mostly it’s his hatred of all things Trumpian: Krugman can not accept that Trump could avoid destroying the economy, and con not imagine that any investor would see things otherwise.

Apparently some folks felt otherwise, and caused unemployment to drop and the market to rise. but then, in September 2017, Krugman’s dire predictions were echoed by Robert Schiller, 2013 Nobel winner, and author of a textbook the majority of schools use to teach market analysis. Robert Schiller, has argued that valuations are extremely expensive. “This stock market bears striking similarities to that of 1929. “The market is about as highly priced as it was in 1929,” “In 1929 from the peak to the bottom, it was 80 percent down. And the market really wasn’t much higher than it is now in terms of my CAPE [cyclically adjusted price-to-earnings] ratio. So, you give pause when you notice that.

What Schiller is referring to is his particular version of the price to earnings ratio, the price of the average stock share divided by the amount of the average earnings per share. Schiller’s CAPE version uses the ten-year, inflation-averaged earnings, rather than today’s earnings, and finds the ratio is high, as the graph below shows. When he made these comments, this ratio was 25, nearly as high as the 1929 peak. The ratio is now higher, 32.74, higher than it stood on “Black Tuesday.” Why this number is important is that the profitability of a stock-share is merely the inverse of the Price/ Earnings ratio. The current ratio, 32.74 suggests that the average dollar’s worth of shares will return about 3.05% (1/32.74 = 3.05%). By comparison, one could buy a five-year treasury bond and get 2.96%. That’s hardly less, and federal bonds are totally safe. More alarming yet, the Federal Reserve has indicated that it will continue to raise interest rates at planned rate of 1%/year for at least the next year. At some point, people will decide bonds are the far better bargain, and will exit stocks en-mass. And then it’s crash-city, or so the theory goes.

The Schiller Price to Earnings ratio as of July 27, 2018. It suggests a crash is past due.

The Schiller Price to Earnings ratio as of July 27, 2018. It suggests a crash is past due.

Shown above is a historical plot of Schiller’s particular version of the price to earnings ratio based on the S+P 500 index, with data going back to 1880. It’s argued that his version using a ten-year, trailing average of corporate profits, is better than the non-adjusted, one year P/E ratio: the version you find in the newspapers. In the newspaper version, the peaks don’t show up until just after the crash because company profits tend to spike along with prices. In this version, profits can’t exactly spike, and  stock crashes show up as valuation peaks. The crash is seen as a consequence to high values of the Schiller P/E.  In terms of CAPE, we are at a more dangerous spot than in 1929. We are more exuberant than in 2008, or when Alan Greenspan warned of irrational exuberance. Schiller: “you give pause when you notice that.”

Schiller Price to earnings ratios are a good predictor of future stock prices. We are past the end of this chart, suggesting a significant loss of stock value ahead.

Schiller Price to earnings ratio plotted versus 20 year stock return. The higher the Schiller P/E, the lower the return. We are past the end of this chart suggesting we should expect a significant loss of capital value.

Stock pull-backs are sometimes gradual, as in 1968 through 1982, but more often the pullback is sudden, a crash. People typically expect a stock return in excess of bonds of 2% or so. They sometimes accept less, and sometimes demand more. Schiller calls the cause “animal spirits.” The fear is that investors will suddenly go back to the historical norm and demand of stocks 2% more return than the 3.05% they get from bonds. If they’d suddenly demand a 5.05% return on stocks to balance, the stock prices would fall by 40%. If the crash happened now, it would take a 40% drop in stock prices to raise the earnings ratio to 5.05%. But if they wait a year, until after the Fed raised the interest rate to 3.5%, we’d expect a greater pull-back 50% or so, a major crash. As early as last year, Schiller has advised moving out of US stock into foreign stocks, particularly European, noting that the US market was  the most expensive in the world. I don’t agree that Europe is a safe haven, but agree that a crash is likely given current return rates, snd the treasury plan to raise interests by 1% over the next year.

Schiller claims that the reason the recession has not hit so far is that people trust Trump. I would not have expected a comment like that from a Yale economist, especially given the constant carping from the TV news. Still Schiller may be on to something. The stock market went up dramatically after the Trump election. There are some advantages to a narcissist president. It also seems Trump’s tariffs are helping to provide jobs, as I predicted. In this quarter, the GDP rose at an impressive 4.1% rate. Gains came even where you’d expect otherwise. US soybean exports rose by 9600% despite a boycott from China. If the economy keeps going like this it might be as much as a year before the correction. A likely scenario is that the Fed raises interest rates, growth slows to 2.5% or less, and with bond interest rates at 3.5% people will get out of stocks in a big way. My expectation is that China will suffer too, and with it Europe. With luck, the Fed will then lower interest rates to 2%, or so. In my opinion interest rates should matches the inflation rate, more or less. I don’t know why the Federal Reserve does not do this, but instead swings its interest rates from very high to low, now aiming for a far excess of inflation rate. I suspect it’s mistake, one that we will pay for soon.

Robert Buxbaum, July 29, 2018. My only other stock analysis post was on bitcoin, In December 2017 I thought it had gone about as far as it would go. Shortly there-after bitcoin value crashed. I hope I don’t cause a crash

The Great, New York to Paris, Automobile race of 1908.

As impressive as Lindberg’s transatlantic fight was in 1926, more impressive was George Schuster driving and winning the New York to Paris Automobile race beginning in the dead of winter, 1908, going the long way, through Russia. As of 1908, only nine cars had ever made the trip from Chicago to California, and none had done it in winter, but this race was to go beyond California, to Alaska and then over the ice through Russia and to Paris. Theodore Roosevelt was president, and Americans were up to any challenge. So, on February 12, 1908 there congregated in Times Square, New York, a single, US-made production car, along with five, specially made super-cars from Europe; one each from Italy and Germany; and three from France. The US car, a Thomas Flyer (white), is shown in the picture below. The ER Thomas company sent along George Schuster, as an afterthought: he was a mechanic and test-driver for the company, and was an ex bicycle racer. The main driver was supposed to be Montague Roberts, a dashing sportsmen, but the fellow dropped out in Cheyenne, Wyoming. Schuster reached the Eiffel tower on July 30, 1908, 169 days after leaving New York. The Germans and Italians followed. None of the French super-cars got further than Vladivostok, and one dropped out after less than 100 miles.

The race was sponsored by The New York Times and Le Matin, a Paris newspaper. They offered a large trophy, a cash prize of $1000, not enough to pay for the race, and the prospect of fame. The original plan was for drivers to go from New York to San Francisco, then to Seattle by ship, and Northern Alaska, driving to Russia across the Arctic ice. That plan was abandoned when Schuster, the first driver to reach Alaska, discovered ten foot snows outside of Valdez. The race was modified so that travel to Russia would be by ship. Schuster took his Thomas to Russia from Alaska, the other two drivers reached Russia from Seattle by way of Japan. Schuster was given a bonus of days to account for having taken the longer route. Because of his detour, he was the last to arrive in Russia. From Japan, the route was Vladivostok, Omsk, Moscow, St. Petersburg, Berlin, and Paris, 21,900 miles total; 13,341 miles driven. Schuster drove most of those 13,341 miles, protected by his own .32-caliber pistol, and mostly guided by the stars and a sextant. He’d taught himself celestial navigation as there were no roadmaps, and hardly any roads.

George Schuster driving the Thomas Flyer, the only American entry, and the only production motorcar in the race.

George Schuster driving the Thomas Flyer with another mechanic, George Miller, the Flyer was only American entry, and the only production motorcar in the race. Note that the flag has only 45 stars.

The ship crossing of the Pacific was a good idea given that, even in the dead of winter, global warming meant that the arctic could not be relied upon to be solid ice. As it was, Schuster had to content with crossing the Rockies in deep snow, and crossing Russia in the season of deepest mud. He reached the Eiffel tower at 6 p.m. on July 30, 1908. The German car had arrived in Paris three days ahead of Schuster, but was penalized to second place because the German team had avoided the trip to Alaska, and had traveled some 150 km of the Western US by railroad while Schuster had driven. The Italian team reached Paris months later, in September, 1908. That the win went to the only production car to compete is indicative, perhaps of the reliability that comes with mass production. That Mr. Schuster was not given the fame that Lindberg got may have to do with the small size of the prize, or with him being a mechanic while Lindberg was a “flyer”. Flyers were sexy; even the car was called a flyer. The Times saw fit to hardly mention Schuster at all, and when it did, it spelled his name wrong. Instead the Times headline read, “Thomas Flyer wins New York to Paris Race.” You’d think the car did it on its own, or that the driver was named Thomas Flyer.

The Flyer crossing a swollen  river in Manchuria.

Schuster in his Flyer crossing a swollen river in Manchuria.

The Times could not get enough of Montague Roberts; the driver of the first leg was famous and photographic. They tried to get Roberts to drive the last few miles into Paris, “once the roads were good”. And Roberts was the one chosen to drive in the hero-parade in New York, Schuster rode too, but didn’t drive. Schuster was feted by Theodore Roosevelt, though, who said he liked people “who did things.” Schuster said he’d never do a race like that again, and he never did race again.

The race did wonders for the reputation of American automobiles, and greatly spurred the desire for roads, but it did little or nothing for the E.R.Thomas company. Thomas cars were high cost, high power models, and they lost out in the marketplace to Henry Ford’s, low-cost Model T’s. You’d think that, in the years leading up to WWI, the US Army might buy a high cost, high reliability car, but they were not interested, and the Thomas company did little to capitalize on their success. The Flyer design that won the race was discontinued. It was a 60 hp, straight 4 cylinder engine version, replaced by lower cost Flyers with 3 cylinders and 24 hp. Shortly after that, Edwin R. Thomas, decided to drop the Flyer altogether. His company went bankrupt in 1912, and was bought by Empire Smelting. The original Flyer was sold in 1913 at a bankruptcy action, lot #1829, “Famous New York to Paris Racer.”

ER Thomas went on to found another car company, as was the style in those days. Thomas-Detroit went on make similar cars to the Flyer, but cheaper. The largest, the K-30, was only 30 hp. The original Thomas Flyer is now in the National Automobile Museum, Reno Nevada. after being identified by Schuster and restored. Here is a video showing the original Flyer being driven by a grandson of George Schuster. There is a lower-power Thomas Flyer (black) in a back space of the Henry Ford museum (Detroit). Protos vehicles, similar to the one that came in second, were produced for the German military through WWI. Their manufacturer, Siemens, benefited, as did the German driver.

Advertisement for the Protos Automobile, a product of Siemens motor company. The race did not include a production Protos but one made specially for the race.

Advertisement for the Protos Automobile, a product of Siemens motor company. The race did not include a production Protos but one made specially for the race.

The Thomas engine (and the Protos) engine) live on in a host of cars with water-cooled, four-cylinder, straight engines. In 1922, Chalmers-Detroit merged with Maxwell and continued to produce versions of the old Flyer design, now with an internal drive-shaft. The original Flyer was powered via a gear-chain, like a bicycle. In 1928, Maxwell was sold to Chrysler. Chrysler persists in calling their high-power, four-cylinder engines by the name Chalmers. As for Schuster, when ER Thomas closed its doors, he had still not been paid for his time as a race driver. He went to work for Pierce-Arrow, another maker of large, heavy vehicles. The “cheaper by the dozen” family (two parents, 12 kids) drove a Pierce-Arrow.

The Great race appears in two documentaries and two general audience movies, both comedies. The first of these was Mishaps of the New York–Paris Race, released by Georges Méliès, July 1908, just about as the Flyer was entering Paris. The second movie version  “The Great Race” was released in 1965. It’s one of my favorite movies, with Jack Lemon as the Protos driver (called Dr. Fate in the movie), Tony Curtis as “The Great Leslie”, the Flyer driver. For the movie, the Flyer is called “The Leslie”, and with Natalie Wood as a female reporter who rides along and provides the love interest. In the actual race reporters from the New York Times, male, traveled in the Flyer’s rear seat sending stories back by carrier pigeon.

Path of the Great Race

Path of the Great Race

As a bit of fame, here’s George Schuster in 1958 on “What’s my secret.” He was 85, and no one knew of him or the race. Ten years later, in 1968, Schuster finally received his $1000 prize, but still no fame. A blow-by-blow of the race can be found here, in Smithsonian magazine. There is also an article about the race in The New York Times, February 10, 2008. This article includes only two pictures, a lead picture showing one of the French cars, and another showing Jeff  Mahl, the grandson of George Schuster, and a tiny bit of the flyer. Why did the New York Times choose these pictures? My guess is it’s the same reason that they reported as they did in 1908: The French car looked better than the Flyer, and Jeff Mahl looked better than George Schuster.

Robert Buxbaum, July 20, 2018. What does all this mean, I’ve wondered as I wrote this essay. There were so many threads, and so many details. After thinking a bit, my take is that the movie versions were right. It was all a comedy. Life becomes a comedy when the wrong person wins, or the wrong vehicle does. A simple mechanic working for a failing auto company beat great drivers and super cars, surpassing all sorts of obstacles that seem impossible to surpass. That’s comedy, It’s for this reason that Dante’s Divine Comedy is a comedy. When we see things like this we half-choose to disbelieve, and we half-choose to laugh, and because we don’t quite believe, very often we don’t reward the winner as happened to Schuster for the 60 years after the race. Roberts should have won, so we’ll half-pretend he did.

The wealth of nations in beer

We generally compare the wealth of nations in dollars per capita, but this is a false comparison. You can not eat dollars, and even if dollars can be exchanged for products or other countries’ currencies with minimum cost, the same is not true for their products. A sack of rice in America costs more than in India; you can not easily buy it at the Indian price. Nonetheless we generally measure the wealth of a county as if all products cost the same everywhere. Based on this, we declare that the citizens of Lichtenstein are the richest on the planet, followed by Norway and Denmark. US citizens not far behind, vastly richer than the people of Africa who we picture living on pennies per day. But pennies in Africa buy more than pennies in America; wealth is spent locally, and things are expensive where people have money.

GDP for various countries in pints of beer per person per year in main city bar or restaurant

GDP for various countries in pints of beer per person per year in main city bar or restaurant

To correct for this local value of money effect, some economists modify consider the ratio of per-capita GDP by relation to the cost of a basket of goods. This is called purchasing power parity, or ppp. By this measure, American’s are not as much richer than Africans, but the problem remains that people don’t all buy the same basket of goods. The Economist magazine has thus suggested correcting ppp by choosing a single consumable, the MacDonald’s Big Mac, a standard product available world-wide. The Economist’s “Big Mac Index” is quite good in my opinion, but it could be better, and I decided to make it better by using beer instead of Big Macs.

It strikes me that typical Africans don’t eat Big Macs — the price is out of range. Meanwhile, in rich countries mostly it’s the poor who eat MacDonald’s (and Donald Trump). The advantage of using beer to measure the wealth of nations is it’s something most-everyone consumes across all social strata. A country is wealthy in terms of many pints of beer a person can buy based on his or her, per-capita GDP.

Shown at left is the top countries from a table I made by dividing the GDP per capita by the price of a pint (or half-liter) of local beer as served in a tavern or restaurant of the major city. Measured this way I find Lichtenstein is still the richest country on earth, now followed by Saudi Arabia and the Czech Republic. Norway is no longer among the richest countries — beer is expensive there, as is labor. The Czech Republic, normally considered a middle-to-poor country, is number 3 because of the low cost of its excellent beer. The US is several stages down, just below Denmark, and barely above Hungary and Kazakhstan. The socialist countries: Russia, Cuba, and Venezuela are as poor in beer as they are in dollars. Socialism distributes wealth without creating it.

Number of beers one can buy on a month's minimum wage in Europe

Number of beers one can buy on a month’s minimum wage in Europe, by Reddit:adilu.

By now you’re wondering about my use of per-capita GDP. Perhaps a better comparison — one where socialism looks better would involve the minimum wage. At right I show a map of Europe in terms of the number of beers one can buy per month based on 40 hour weeks at the minimum wage. Several countries are greyed out: Italy, Austria, Sweden, Finland, Lichtenstein, etc. These are mostly rich countries bu have no minimum wage. Based on the data, Belgium’s working classes are the best off, with Ireland and England not far behind. Germany’s workers look like they are doing well, but they don’t really have a minimum wage (the chart, by Reddit editor adieu assumes one based on a proposal). The United States’s minimum worker is poorer in beer (327/month) based on a minimum wage of $7.85 and an average cost of beer about $4/pint (bar + supermarket). He is richer than the French, Poles, Italians, Norwegians, Danes, Austrians and Swedes in beer, and better off than the Turks and Russians too. It’s clear that high minimum wages harm community wealth and job prospects. Though some at the bottom of the work scale are left dry at the bar.

Robert Buxbaum, July 18, 2018. I write these blogs to help me think. If you’d like to see more of the wealth of nations in beer, I’ll be happy to provide.

Trump, tariffs, and the national debt

My previous post was about US foreign policy, Obama’s and Trumps. This one is about Trump’s domestic policy as I see it. The main thing I see, the pattern is that I think he’s trying to do is pay down the national debt while increasing employment. So far unemployment is down, but borrowing is not. I suspect that a major reason for the low unemployment is that Americans (particularly black Americans) are taking jobs that used to be held by Mexicans. As for US borrowing, it’s still bad. For his first budget, Trump, like all other recent politicians caved to the forces that favor borrow and spend than to pay back. In this century, only Wm. McKinley, Theodore Roosevelt, Taft, Harding, and Coolidge managed to pay down the national debt. But only one man, Andrew Jackson, managed to pay it off completely. Jackson’s picture hangs in the pride of place in the Trump white house, something that I find significant. I suspect that Trump’s tariffs and spats are intended to pay down the debt without raising unemployment, or weakening the military. Andrew Jackson is his idea of “Make America Great Again.”

All recent presidents have raised the national debt. Trump claims he will shrink it.

All recent presidents have raised the national debt. Trump data to April 20, 2018.

As the graph above shows, if Trump plan is to pay down the debt, he is not succeeding. Trump is overspending — at a somewhat slower rate than other recent presidents, but in 1 1/4 year he’s increased the debt by 6.3%, about $1220 B. He’s saved a few billion by reduced payments to the UN, and to the EU for climate studies, and he’s asking NATO to pay more for Europe’s defense, but he’ll have to do a lot more, and the rest of the world is already unhappy with him.

Many US economists — Keynesians – are not happy with him for another reason. They claim that debt is good, and that borrowing increases employment. As proof they note that FDR borrowed and spent heavily though the 1930s,and we got out of the depression. Other economists point out that it took longer in the US to get out of the depression than in many other countries. More recently, under Jimmy Carter, deficit spending created a combination of high inflation and high unemployment, “stagflation,” suggesting that Keynes should be modified to “Neo Keynesians” who claim you can overspend if you don’t outspend the GDP growth rate. Sorry to say, even in these terms, Obama and GW Bush overspent badly, as did Reagan before them (see graph below). Obama raised the debt from 65% of the GDP to its current 105%, and GW Bush raised it from 50% of GDP to 65%. This borrowing did not increase employment, or raise the standard of living for most Americans, though several at the top became fabulously wealthy. As Alan Greenspan noted, “If national borrowing was a path to wealth, Zimbabwe would be the richest country on earth.” I’m more of a hard money man, as Greenspan was, inclined to think that a balanced budget is good, and that tariffs are good too.

Ratio of US government debt to GDP

Ratio of US government debt to GDP

As of June 1, 2018, Trump has imposed ~20% tariffs on five items: wood, steel, aluminum, washing machines, and solar panels. Combined, these items constitute 4.1% of our imports, $130 B/ year. Taxed at 20%, the US will collect $25 B/year. it’s a step, but I suspect that Trump knows that, if tariffs are to wipe out all of our deficit, he’ll have to impose a lot more, about 40% on all of our imports ($3,100 B/year). Trump may yet do this, and may yet cut spending, and put a lot more America to work. My sense is that this is his aim.

The next step in the Trump MAGA plan involves adding another $35B to the list of items being taxed; that’s about 1.1% of US imports (5.2% total). In response, our trade-partners have complained to the press and to the world court, and have imposed their own tariffs — so far on about $100 B of US products, mostly food items, like bourbon and cheese, chosen to hit Republicans in politically – sensitive states: Tennessee and Wisconsin. Canada now taxes US cheese at over 100%. It’s an effort to embarrass Trump and get Democrats elected in 2018. If these tactics don’t work, Trump will impose another round, e.g. on foreign-made cars and motorcycles. I’d also expect him to cut NATO funding unilaterally, too, as a counter-slap to the EU.

US unemployment by race

US unemployment by race, data to May 2018.

Speaking of Keynesian economists, Nobel Laureate economist, Paul Krugman of the New York Times has been predicting severe job losses, and a permanent stock collapse since 2016, and especially following Trump’s election. Virtually every week he announces that the end is near, and every month the economy looks better. But he’s not deterred, and neither are most economists. In a survey of nearly 100 economists by Reuters, 80% said that Trump’s policies will hurt the U.S. economy, and the rest said there would be little or no effect.[1] . So far it looks like they are all wrong. Unemployment is at record lows, particularly for African-Americans (see chart above); we’re adding new jobs at the rate of 200,000 new jobs per month, nearly 0.8% of the population per year. Inflation is a modest 2.3%, GDP growth is excellent, at 3.2% (or an incredible 4.5%). All we need now is a sensible immigration policy plus some healthcare reform, a modified social security tax, and for the economy to stay this way for another 5-10 years. It’s unlikely, but that’s the plan.

Robert Buxbaum, July 5, 2018. I’d hoped to see the employment and deficit numbers for June by now, but it’s not out. I’ve also argued that free trade is half right, as there is a benefit to workers, And there is a certain greatness that comes from paying your bills. Today, the EU offered to lower some auto tariffs if Trump does not move forward.