Financial Methods

Food Prices Climbing Due to Ethanol

This month, the price of milk in the United States surged to a near-record in part because of the increasing costs of feeding a dairy herd. The corn feed used to feed cattle has almost doubled in price in a year as demand has grown for the grain to produce ethanol. ¹

So let's review the process.

1.  Government takes money from consumers via taxes
2.  Government pays special interests to burn food
3.  Consumers pay more for food

Interfering with free markets has consequences.  In this case, encouraging the burning of corn through subsidies results in less corn available to eat (or feed to livestock).  So prices for corn, beef, poultry, and now ice cream increase.

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Source:

1. Suzy Jagger and Carl Mortished. Ice-cream makers frozen out as corn price rises.
The Times. July 16, 2007.
http://business.timesonline.co.uk/tol/business/markets/united_states/article2080599.ece

© 2007 Michael Cale

10 Principles of Economics

by Yoram Bauman at http://www.standupeconomist.com/

Education is the Key To Income

Tyler Cowen in the New York Times cites a major factor in why different workers earn money at different rates - education.

For the economy as a whole, labor’s share of national income has stayed roughly constant at just above 70 percent. What has changed is that highly skilled laborers earn more labor income than low-skilled workers. ¹

Starting about 1950, the relative returns for schooling rose, and they skyrocketed after 1980. The reason is supply and demand. For the first time in American history, the current generation is not significantly more educated than its parents. Those in need of skilled labor are bidding for a relatively stagnant supply and so must pay more.¹

Income distribution thus depends on the balance between technological progress and access to college and postgraduate study. The problem isn’t so much capitalism as it is that American lower education does not prepare enough people to receive gains from American higher education. ¹

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Source:

1. Tyler Cowen. Why Is Income Inequality in America So Pronounced? Consider Education .
New York Times. May 17, 2007.
http://www.nytimes.com/2007/05/17/business/17scene.html

© 2007 Michael Cale

California Overtakes Hawaii for Highest Gasoline Prices

California leads the nation with gas at $3.27. Hawaii is now second with an average price of $2.98. In fact, the top five are all western states. Nevada, Washington and Oregon follow the Aloha State. ¹

The national average retail price is $2.71 as of April 2.

State tax on gasoline is higher in California than in Hawaii.  California imposes an 18 cents per gallon tax versus Hawaii's 16 cents per gallon tax.  This is over and above the 18.4 cents per gallon tax imposed by the federal government.²

The sales tax in California is higher, 6% versus the 4% rate in Hawaii.   In addition, California charges sales tax on the selling price (which includes the per-gallon excise tax).  Double taxation, anyone? Hawaii, however, excludes the excise taxes when calculating the sales tax. ²

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Source:

1. KHNL. Gas Prices High, Price Gouging Bill Stalls.
April 4, 2007.
http://www.khnl.com/Global/story.asp?S=6327882

2. Federal Highway Administration. Monthly Motor Fuel Reported By State.
March 9, 2007.
http://www.fhwa.dot.gov/ohim/mmfr/sep06.pdf (pdf link)

© 2007 Michael Cale

Compacency In A Dangerous World

Historian Niall Ferguson and investor complacency is the focus of a recent Barrons article (subscription required).

Ferguson comments on the"paradox of diminishing risk in an apparently dangerous world."

One of his key themes is the economic, social and political parallels between the world today and on the eve of World War I. The period from 1880 to 1914, which he calls "the first age of globalization," has more in common with our own time than "any other intervening period," he says. By recognizing the similarities, it follows, we can also learn from past mistakes.

The pre-war era was characterized by relatively steady economic growth, low inflation, growing world trade, benign and liquid capital markets and a widespread belief in the ability of Great Britain, the world's reigning military power, to keep world peace. Similar circumstances prevail today, though the U.S. has assumed the role of global cop.

The first age of globalization ended in the carnage of World War I and ensuing revolutions and financial dislocations. While Ferguson doesn't see another world war looming, a geopolitical shock, he argues, could dry up financial liquidity, now abundant, and shut global stock exchanges, as happened after war broke out in 1914.¹

Chart courtesy of Barrons

In Ferguson's view, Iraq and the greater Middle East are the most unstable parts of the world today, and the most likely site of the next major war, because of the disintegrating situation in Iraq, ongoing tension between the U.S. and Iran, and rising antiwar sentiment in America. All the more reason for investors to consider the potentially disastrous implications of an American military retreat in the Mideast, and understand that liquidity can vanish quickly, as it did on the eve of World War I.

"Some people think about political and military power, and other people think about money," he says. "There is a tendency not to see how intimately connected they are."

In today's world, especially, it is essential to think about both.¹

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Source:

1. Andrew Bary. Wake-Up Call.
Barrons. March 12, 2007.
http://online.barrons.com/article/SB117348419778832743.html

© 2007 Michael Cale

Why the Fed Is Worried About Inflation

Productivity down, labor costs up.

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© 2007 Michael Cale

Minimum Wage Up, Teenage Employment Down

Action, reaction.  Drop a ball.  The ball falls, hits the ground and bounces.  It's predictable.  It's mathematical.  It's scientific. 

Similar relationships exist in economic.  Raise prices and demand falls.  Labor is not exempt from this relationship.

Chad Graham reports from Arizona:

Tom Kelly, owner of Mary Coyle Ol' Fashion Ice Cream Parlor in Phoenix, voted for the minimum-wage increase. But he said, "The new law has impacted us quite a bit."

It added about $2,000 per month in expenses. The store, which employs mostly teen workers, has cut back on hours and has not replaced a couple of workers who quit.

Kelly raised the wages of workers who already made above minimum wage to ensure pay scales stayed even. As a result, "we have to be a lot more efficient" and must increase menu prices, he said. ¹

The largest segment of the labor force earning minimum wage are young, unskilled, and do not entirely support their own household.  They often still live with their parents.

Yet an interesting thing happens when uneducated, unskilled workers become employed and stay on the job - they become more skilled at their job.  They become skilled workers.   They become skilled workers earning more than the minimum wage.

Over time, low income workers tend to become middle income workers and often high income workers later in life.  One thing they have in common is that they all had to get that first job.  Minimum wage laws ensure that there are fewer first-jobs available.

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Source:

1. Chad Graham. New wage boost puts squeeze on teenage workers across Arizona .
The Arizona Republic. Feb. 10, 2007.
http://www.azcentral.com/news/articles/0210biz-teenwork0210.html.

© 2007 Michael Cale

Bi-Coastal Housing Pain

As housing softens nationwide, the east and west coast seems to face the most difficulty .  These two regions previously enjoyed spectacular price increases.

From Northern Virginia:

The pace of home construction in Loudoun County slowed dramatically last year, dropping to levels not seen in a decade, according to recently released county figures.  By the end of 2006, the county had issued 3,284 residential building permits, 35 percent fewer than the year before and fewer than half the number issued at the peak of the Loudoun housing boom in 2003, according to a January report by the county's Department of Economic Development.¹

From the West Coast, speculation is beginning to slow:

Flippers bailed from California's troubled housing market in 2006, according to a report today by a Southern California real estate researcher. ``There's a lot more caution in the wind when it comes to investors,'' HomeSmartReports.com President Michael Ela told Bloomberg. ``The margins are getting a little skinnier, and there aren't as many people making money in the flipping arena.''²

These are both positive signs.  Real estate price growth had become unsustainable in many markets.  As a result, supply has exceeded demand.  Eventually, this imbalance will correct itself.

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Source:

1. Sandhya Somashekhar. Home Construction Hits 10-Year Low.
Washington Post. February 4, 2007.
http://www.washingtonpost.com/wp-dyn/content/article/2007/02/02/AR2007020202153.html

2. Frank Michael Russell. California housing slump made 2006 a bad year for flippers.
Mercury News. January 11, 2007.
http://www.mercurynews.com/mld/mercurynews/business/columnists/business_update/16438457.htm

© 2007 Michael Cale

The Slowdown Continues

Many transportation companies continue to confirm the softening of the economy. 

One of the larger trucking companies, Swift (SWFT), posted a 5% decline in revenue. Swift CEO Robert Cunningham noted (emphasis mine):

The quarter reflects one of the most challenging freight environments in recent memory, and the normal holiday surge did not materialize for a variety of reasons. We were also impacted by the downturn in the housing and automotive markets, and the increase in Class 8 truck builds prior to the new 2007 EPA requirements, both of which added capacity to the market. ¹

The CEO of USA Truck (USAK) echoes this sentiment -

We experienced declining demand for truckload freight services throughout the quarter consistent with the declining truck tonnage reported by the American Trucking Associations. This was the most difficult operating environment that we have seen in several years due to the deteriorating demand and the absence of the normal peak shipping season.²

One exception has been the railroads, as shippers seek out lower costs (but longer transit times). Stronger demand allowed the Union Pacific (UNP) to post record profits. Volume was up, but at a modest pace.

Business volumes, as measured by total carloads, increased three percent to a record level of 9.9 million.³

The cratering of the housing market is cascading into other areas of the economy. 

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Source:

1. Swift Transportation. Swift Transportation Reports Earnings for the Fourth Quarter and Year Ended 2006.
Press Release. January 24, 2007.
http://phx.corporate-ir.net/phoenix.zhtml?c=67346&p=irol-newsArticle&t=Regular&id=953998&

2. USA Truck. Press Release.
January 25, 2007.
http://www.usa-truck.com/investor_relations/Press%20Releases/4th%20Quarter%202006%20Earnings%20Release.pdf

3. Union Pacific. Union Pacific Reports Record Fourth Quarter and Full Year Earnings.
Press Release. January 25, 2007.
http://www.up.com/investors/attachments/earnings/2006/4q2006pressrelease.pdf

© 2007 Michael Cale

At the time of publication, Mr. Cale held a long position in JBHT.

Are We In A Recession Already?

It's been a rough few months for economic indicators.  There have been recent low readings from productivity, durable goods, GDP, ISM, and of course, housing.

First, productivity - nonfarm output per hour  - took a hit last quarter.  It was the lowest year-over-year reading since 1997. 

Thus, Greenspan's 'productivity miracle' of high growth and low inflation may be coming to an end. 

 

Durable goods ex-defense ex-aircraft fell by 5.1% in October.  Normally, I wouldn't put a lot of emphasis on a one-off event, but this one caught most by surprise.   We could see a rebound in the next report, but time will tell.

Fed Chairman Bernanke gave us a small indication about the outlook for current-quarter GDP this week:

the indicators in hand suggest that real GDP growth this quarter is likely to be in the same general range that it was in the second and third quarters. ¹

Annualized third quarter GDP was just revised from 1.6% to 2.2%.  Yet this remains below the 2.6% rate in Q2 and the 3.5% average growth over the last two years.  Based on the most recent durable goods report, fourth quarter GDP may be below 2%.  There is no question that the slowdown is on.  The open questions are how long? and how low?

The ISM Manufacturing index has dropped every month since August.  The November reading showed contraction.  This ends 42 consecutive months of expansion.  New orders, production, and employment were down; prices were up.  The ISM index for services is still showing expansion. 

The Truck Tonnage Index from the American Trucking Association has suffered the largest year-over-year drop since 2001 [see the excellent blog The Big Picture].  Year-to-date through October the index is down 2.1% versus 2005.   It's true that rail volumes have been up and that one can argue that the gift-card phenomenon has pushed the traditional Christmas inventory build-up deeper into Q4.  Yet it is hardly good news for the holiday shopping season - if the economy were firing on all cylinders, there would be plenty of freight for trucks, trains, and gift cards.   

The housing sector is undergoing a meltdown.  The national median home price for existing home sales has hit the largest year-over-year drop on record.  The inventory of unsold homes, currently over a 7-months supply, continues to rise.  Don't expect prices to stabilize until inventories do.²

The yield curve remains inverted with short rates higher than long rates.  This inversion has been with us for most of this year.  It is only one indicator, but it is flashing - 'Recession Coming'.   For more on this indicator, see this article on the New York Fed web site.

Chart courtesy of Bloomberg.

It's unlikely that we are in a recession at the moment, but slowing growth, declining productivity, the inverted yield curve, and an imploding housing market make a 2007 recession a very real scenario.

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Source:

1. Ben Bernanke. The Economic Outlook.
Speech before the National Italian American Foundation. November 28, 2006.
http://www.federalreserve.gov/boarddocs/speeches/2006/20061128/default.htm

2. National Association of Realtors. Existing Home Sales Rise in October, Market Stabilizing.
Press Release. November 28, 2006.
http://www.realtor.org/press_room/news_releases/2006/ehs_oct06_existing_home_sales_stabilizing.html

© 2006 Michael Cale