The Broken Price Signal at the Heart of Financial Markets

There’s a bit to discuss today…Aussie unemployment, deficit blowouts, US GDP numbers, euro interest rates and Twitter craziness. So let’s get stuck in…

Firstly, we must confess we’re not sure whether bad news is good news or good news is bad news anymore. Because with every data release, it seems like the market spins around to see what the respective central bank will make of it. Is it good/bad enough for less or more monetary easing…is it good/bad enough for taper on/taper off? They’re the only questions that matter these days.

And then sometimes the meaning of the data is whatever you want it to be. Take the Aussie employment statistics for October, released yesterday. The Financial Review reported:

 ‘Employers boosted hours worked last month at the fastest pace in 18 months, a tentative sign that the nations’ lacklustre labour market is on the cusp of recovery.

The report went on to say the increase in hours worked represented a silver lining in an otherwise soft report. And that’s how the market viewed it too…as soft. The stock market retreated yesterday (despite a strong move in the US to all-time highs) and the Aussie dollar weakened.

David Rogers at Dow Jones saw the release a little more accurately:

 ‘THE Australian dollar fell today after disappointing employment data left the door ajar for further interest rate cuts to stimulate the economy as it struggles to adjust to the end of the mining investment boom.

While total employment rose by 1,100 (seasonally adjusted) full time jobs fell by 27,800, with a 28,900 increase in part time jobs making up the difference. The overall unemployment rate now stands at 5.7%.

We think the employment market will get worse before it gets better. There is a great hope that some form of investment will take over from the considerable drop off in mining investment now occurring, but it’s not going to happen. The high paying jobs in the mining construction industry will be lost for good.

An easy money-fuelled house price boom is not going to lead to a housing investment boom while idiotic governments continue to restrict supply. They do so because restricted supply maintains high prices, and high prices line state government coffers via huge stamp duty revenues.

It’s not just the states scrounging around for income. The Federal government could do with a bit more too. As the government prepares to release its mid-year economic and fiscal outlook, the warnings are out that the budget numbers don’t look pretty. We could be in for a deficit this year of $50 billion. That’s up from Treasury’s August estimate of $30 billion.

Of course, Joe Hockey is doing what any self-respecting politician would do…blame the other side for the blowout. But the $8.8 billion one-off grant to the Reserve Bank and the repealing of tax changes announced under Labor is the main reason behind the rising deficit. Plus, revenue forecasts continue to deteriorate, so underlying economic weakness remains.

Not so in the US though. Economic growth in the September quarter came in at a robust 2.8%, well above expectations of 2% growth. But the headline number masked underlying weakness. Inventory accumulation (production sitting on shelves and not consumed) accounted for 0.8 percentage points of the growth number.

According to the Wall Street Journal:

 ‘Americans during the third quarter increased their spending at a 1.5% pace, matching only one other quarter for the lowest spending growth since 2009. Companies cut spending on equipment—a key indicator of business investment—for only the second time since the recovery began in mid-2009.

The rise in inventory means growth next quarter will probably be much weaker, perhaps as low as 1.5%. That’s near ‘stall-speed’ for the US economy.

The market wasn’t sure whether to interpret the data as good news or bad news. Was it ‘good’ because it was bad, meaning the Fed will continue spraying liquidity all over the place? Or was it bad because it was above expectations and suggestive of a Fed turning the pressure down on its liquidity hose?

Or maybe it was just bad. The stock market fell heavily. Current high prices don’t contain much room for earnings disappointments and a lacklustre economy means earnings growth is going to be hard to achieve in the coming quarters.

But you can’t disappoint on earnings if you don’t have any! Which is why Twitter surged 73% on its first day as a listed company, closing at US$44.90 following an IPO at $26. It doesn’t yet have any earnings, but the market still gives it a value of $31 billion.

Twitter’s performance is a sign of the times. Sure, it may make money, and its growth may be rapid, but you’re already paying for that profit growth. Its first day performance reflects the current craziness and speculative nature of Wall Street, not its genuine prospects.

Meanwhile, over in Europe ECB boss Mario Draghi reduced the main refinancing rate in the Eurozone by 25 basis points to 0.25%. The cut was in response to low inflation (currently 0.7%) and as it was unexpected, the euro initially fell sharply.

However in the scheme of things the decision is not a big deal. Europe is undergoing deep structural reforms and will have low inflation and low interest rates for years. The biggest risk is that the debt-to-GDP ratios of the heavily indebted southern European nations continue to blow out.

Italy’s debt-to-GDP ratio, for example, is heading towards 135%, up from 120% in 2012. There’s trouble brewing again in Europe. Debt restructurings will have to take place.

Maybe Italy could sell some of its massive gold hoard, officially the third largest in the world, to relieve its debt burden? Except doing so would hardly put a dent in its debt obligations. At current prices, Italy’s gold holdings are worth just US$102.4 billion. According to the Economist, Italy’s outstanding government debt is US$2.6 trillion.

Even at $20,000 an ounce, a gold sale would only wipe off a bit over US$1.5 trillion of debt. So it’s safe to say that at these prices, Italy won’t be selling an ounce of its gold.

Bizarrely, despite the cut in ECB interest rates and the underlying weakness in the US economic data, gold ‘prices’ fell overnight. And don’t forget with US payrolls data out tonight, those trading pieces of paper representing gold will have another wild trading session to contend with.

When you think about it, a falling gold price amidst a completely dysfunctional global economic backdrop signals a victory for the world’s economic planners. It represents the true corruption of price signals at the heart of the global financial system. When the one asset that’s meant to provide a warning that something is wrong no longer throws off the correct price signals, you know the system is broken beyond repair.

But we’re exaggerating and showing our bias. How dare we question the market? And besides, it’s only interest rates, foreign exchange markets and oil prices that are subject to manipulation. Gold is just a barbarous relic.


Greg Canavan+
for Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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