It is time once again to throw caution and wisdom to the wind and
actually make my 11th annual forecast. I have to admit this is the
most stressful letter I write each year. I do at least 5-10 times more
research and thinking about this issue than any other. On a positive
note, this may be one of the more optimistic forecast letters I have
done in a long time. But there are some asterisks, as always. We will
survey the world, trying to peer through the fog of the future. There
are some very interesting side trails we will want to explore. Did you
know some events in Russia could have real ramifications for inflation
in China, the US, and the world? I pay attention to the background
details and bring them to you. So settle back as we tour the world.
!! How Did We Do In 2010? !!
I rarely go back and read my annual forecast until the following year,
and this year was no exception. So I was pleasantly surprised to see
that my batting average was pretty good. You can read the first two
letters of last January, which comprised the forecast, at
http://www.johnmauldin.com/frontlinethoughts/archive/2010/01/.
After noting my bearishness on the yen, euro, and pound (against the
dollar), I wrote:
"So, where are the strong currencies going forward? The Canadian
dollar is on its way to parity. I would want to own the Aussie, if I
was a trader. Maybe the Swiss franc, although it is so high on a
parity-value basis right now. [Note: if the Swissie was high this time
last year, it is wildly overvalued now. And there is nothing the Swiss
can seemingly do about it. Their central bank has lost billions trying
to fight appreciation against the euro. As Dennis Gartman notes, this
fighting the euro may be the all-time largest losing trade in
history.
"But the currency I want the most if I am a central banker [or an
individual] is that barbaric yellow relic, gold. Just as India has
recently bought 200 tons of gold, I think central banks in other
emerging nations will want to buy more, too. [They continued to do
so!] They all have relatively little gold as a percentage of their
reserves. Look for that to change.
"I also like gold in terms of the euro, the pound, and the yen –
more than I like it in terms of the US dollar, but even there I like
gold long-term, at least until we get some fiscal sanity."
I think that is reasonable for this year as well. I am less
pound-bearish than I was a year ago, as it has already dropped a lot,
but think the yen and euro could come under real pressure. The
Canadian loonie blew through parity, but is still strong. I think the
Aussie dollar could see some relative weakness this year, for reasons
we will go into later, and I think a basket of Asian currencies will
be the stronger bet. Asian countries must deal with higher inflation
by tightening monetary policy or allowing their currencies to rise. I
think it will be the latter, as they will not want to choke off growth
with higher rates, which would attract more dollars and mean potential
capital controls on the order of Brazil's.
I was bearish on equities in 2010, which was the right stance in the
US until late August, when Bernanke gave his Jackson Hole speech,
telling us that we would see QE2, which set up rallies all over the
world. Things change. I have to admit I was somewhat surprised he
decided to launch QE2. I think it is ill-advised, and that money is
now setting up bubbles in emerging markets and commodities. But they
are going to continue until June. What will happen then? Not much, as
monetary policy has a time lag, but it suggest headwinds in risk
assets beginning late in the year.
While on the stock market, let me revisit a theme from a few weeks
ago. There are all sorts of indicators from any number of services
that I follow that are telling us about the possibility of a
short-term sell-off. But given that the Fed and other major central
banks are maintaining an easy stance, the medium-term outlook
following a drop should be a return to a bullish trend.
My friend Dr. Prieur du Plessis of Plexus, in South Africa, sent me
the following graphs about world Purchasing Manager Indexes (the
equivalent of ISM in the US), for both manufacturing and services.
Source: Investment Postcards (You can sign up for free if you like.)
What you will notice is that most of the world except Japan, Greece,
and Australia is expanding in the *manufacturing* chart below, some
countries aggressively so, like Germany. Globally, the world is
expanding and (subject to the caveats later in the letter) should
continue to do so this year.
And below is an estimation of what the *services* chart looks like.
Again, most countries are in an expansion mode. It is rather
interesting to see which countries are doing well in both sectors, and
it seems odd that Australia is not doing all that well in either.
!! Russia And The Roots Of World Inflation !!
I hinted at something in Russia that threatens to cause inflation. No,
it is not some nefarious scheme by Putin or Medvedev. It is Kamchatka,
or more specifically volcanic activity in the Kamchatka Peninsula.
There is a reason the weather is so harsh this winter, and a big part
of that is Kamchatka.
I am a voracious consumer of information from a wide variety of
sources. Most of it never gets into this letter, but it helps me
understand what is going on in the background. As my friend Don Coxe
says, it is what is on page 16 that will be important in the future. I
read a lot of page 16s.
One of those "Outside the Box" sources is the _Browning
Newsletter_ on climatology, a completely different look at weather
from the normal meteorological view we get in newspapers and on TV.
Started some 36 years ago by Ibn Browning, famed and (then somewhat)
controversial climatologist, it is continued today by his daughter
Evelyn Browning Gariss. As an aside, I met Ibn many years ago, when he
would regularly speak at the New Orleans conference. He was
fascinating and brilliant.
Climate as a whole goes through cycles. If we look to the past, we can
better understand the future. Evelyn Browning Garriss has succeeded
with this idea for 20+ years. Each month, I get her letter on weather
patterns. It is somewhat technical, and admittedly will take a few
issues and some study to get your head around, but once you do, oh my.
There is a reason Australia is undergoing severe rains and that the
north of the US and Europe are experiencing serious winters.
First, the Pacific is going through a cooler period, called La Nina
(with this one being particularly strong), and the Atlantic is going
through a warmer period. This would normally change weather patterns
in rather predictable ways. But then throw in the Kamchatka volcanoes,
which are throwing massive amounts of dust into the air, causing the
Arctic to be even colder and Arctic winds to push farther south, and
you get a very drastic change in patterns.
Australia's wheat crop is down by 10%, but the bulk of it has been
so damaged by the worst rain in a hundred years (by far) that it is no
good as human food and can only be used to feed animals. Throw in
drought in Russia, severe drought in Argentina, floods in Brazil and
Venezuela, odd weather in the agricultural parts of China, and you get
rising food costs all over the world – all because Putin cannot keep
his volcanoes under control. (But hey, he's controlling everything
else!)
If those volcanoes don't back down, there is the real possibility
that this year's bad weather could repeat.
As Evelyn writes this month:
"Basically, both the Pacific and Bering plates are subducting
(sliding beneath) under [the Kamchatka Peninsula] and each other. Just
as fenders crumple during a car wreck, so the Kamchatka Peninsula
surface is buckling with mountain ranges. When the ocean plates sink
deep enough, portions are melted by the intense heat generated within
the mantle, turning the solid rock into molten magma. The magma
bubbles up through the crust, ultimately bursting to the surface and
forming volcanic eruptions.
"As a result of all this geological activity, Kamchatka tends to be
somewhat active – but recently it has been ridiculous! Since late
November, Kizimen, Sheveluch, Karymsky, and Kliuchevskoi have been
erupting almost constantly. Most of the eruptions have ranged from
2-10 km (1.2-6.2 miles) high. While the smallest eruptions have caused
only minor local disruptions, the larger ones have entered passing
fronts, cooling temperatures, altering air pressure, and increasing
precipitation.
"Volcanic ash screens out incoming temperature, cooling the air
below. This lowers air pressures which, in turn, changes wind
patterns. In particular, in polar regions it appears to weaken the
Arctic Oscillation winds. When the Arctic Oscillation turns negative,
that is, when the winds weaken, the cold air normally trapped around
the North Pole surges south."
She was writing months ago about the weather that we see today, so
when she tells us that it's possible we'll see a repeat next year,
I pay attention. This could further exacerbate food costs and force
emerging-market central bankers to fight inflation by allowing their
currencies to rise. Weather makes a difference.
!! The US Will More Than Muddle Through !!
I think of a Muddle Through Economy as around 2% growth. That is
enough to keep things going forward, but not enough to substantially
dig into unemployment or raise incomes. The entire last decade was a
Muddle Through decade, with growth averaging 1.9%. After I wrote about
a Muddle Through decade at the beginning of the last one (in 2002), I
caught some flack during the middle years of the decade. Turns out to
have been a pretty good call, though. I still think we are in for a
repeat, over the coming decade, of slower growth on average than we
would like, but not this year. Let's look at some reasons why.
First, the Bush tax cuts were extended. Not doing so would have put us
into recession. One could make an argument that not extending them for
the rich would not have pushed us back into recession, but it would
have been the wrong policy at a time of high unemployment.
Somewhere between 50-70%, depending on whom you want to listen to, of
the "rich" are small business owners. I know something about the
entrepreneurial mindset, as I am a serial entrepreneur. I do two
things when I get some extra money: I invest some and then look for
ways to put it to work to grow my business. The more I have the more I
try to grow the business.
That is the way the entrepreneurial mind works. For whatever reason,
we want to grow, whether we are running a Korean deli in Manhattan or
a financial services firm or an electronics manufacturing company. We
look for new markets and products, which usually means more jobs. When
times get slow we pull back, hoping to last until things get better.
Small businesses are the backbone of job creation in the US. Yes, some
rich lawyers and bankers get by with lower taxes, but that is the
price of leaving businesses with more of their profits to reinvest.
My friend Bill "Dunk" Dunkelberg, Chief Economist of the National
Federation of Independent Business, notes that prospects for future
job growth look better than at any time since the beginning of the
Great Recession. Look at the graphs from his latest survey:
"Reports of net job creation continued to oscillate around the
"0" line in December. Asked about changes in total employment over
the last three months, 13% of owners reported increasing employment at
their firms by an average of 3.5 workers while 14% reported reducing
total employment an average of 2.9 workers per firm. Clearly, no surge
in hiring in December. This produced a reduction of -0.07 workers per
firm, basically unchanged from the "0" October reading and +0.01
reading in November. In normal times, this measure would be in the
range of 0.1 to 0.2 workers per firm (chart below). Still, the percent
reporting higher employment levels is the second highest reading since
December, 2007 (the peak of the last expansion according to the
National Bureau of Economic Research) and the percent of owners
reporting lower employment was down 2 points from November.
"The good news is that the two job creation indicators, job openings
and job creation plans both reached new recovery highs. The percent of
owners reporting hard-to-fill job openings rose 4 points to 13
percent, the best reading in 24 months. This indicates that the
unemployment rate should improve in December and the months ahead.
Plans to create jobs gained 2 points, rising to a net 6% of all
owners, the best reading in 27 months. These indicators point to a
pickup in job creation activity in the first quarter of 2011. But the
small business sector continues to underperform on job creation in
this recovery compared to other recovery periods (charts below)."
Looking at the charts below, we can see a bit of light at the end of
the unemployment tunnel.
!! December Unemployment Better Than Headline !!
I know that everyone expects me to tell them that the headline number
of 103,000 was too soft. And on the surface they would be right. But
there were revisions of a plus 70,000 for the last two months. We have
now seen four months of upward revisions in a row. (More on that
later.)
And the household survey showed an increase of 297,000 jobs. If you
adjust that to match the establishment survey, it would show a surge
of 500,000 jobs! Now, the household versus the establishment surveys
are extremely noisy, as the following chart from my fishing buddy
Stuart Hoffman of PNC shows. Note the wide divergences of the last
five months.
At the risk of boring long-time readers, let me address the problem of
the unemployment numbers at turning points in the economy. The
establishment survey, which is the number we read as the
"headline" number, is created by calling up a statistically
significant percentage of established businesses every month and
asking them how many people they employ. Almost by definition they do
not poll small businesses and start-ups, which is where the job
creation really happens. They have to make an estimate of those jobs,
and this is called the birth/death ratio.
The B/D ratio is based upon past trends. There is no other way to do
it. The BLS does its best at guessing the right number in a systematic
way. And usually it is not all that bad a guess. Except – except –
at turning points in the economy. When the economy starts to recover
from recession, they underestimate the number of jobs. When the
economy is rolling over into recession, the trends they use force them
to overestimate the number of jobs. As the years go by and they get
better data, they go back and revise their numbers.
Remember the jobless recovery of the Bush years? A few years later, it
turned out that job growth was pretty good, at least compared with the
initial estimates. But did anybody care three years later? Did it make
the front page of the _Wall Street Journal?_ No, as no one cares a
lick about old data.
The key is to watch the _direction_ of the monthly revisions. As noted
above, it is now four months of upward revisions. That is a positive.
We need that to continue.
The negative is that it will be years before we get back to a 5%
unemployment rate. We will need 5-6 years of 2.5 – 3 million jobs a
year to get there. We have never done even two years in a row like
that. Unemployment is still going to be a headwind for some time to
come, and that is likely to keep a lid on incomes, which is not good
for final sales. As David Rosenberg notes:
"While the details were obviously better than the headline, it would
be a mistake to read much into the unexpected decline in the
unemployment rate, which fell to 9.4% from 9.8% – the lowest it has
been since May 2009 (when the economy was still technically in
recession) and the sharpest one-month decline since April 1998. While
some of this 'decline' did indeed reflect the rebound in Household
employment, it was largely due to the sharp decline in the labor force
participation rate, which tumbled to a 27-year low of 64.3% in
December from 64.5% in each of the prior two months. The culprit:
discouraged workers soared to a new record high of 1.32 million."
As employment starts to actually rise, people who have give up looking
for work will want to come back into the workforce. As they start
looking for jobs, they will be counted as unemployed. And then the
unemployment number will stay stubbornly high.
!! A Very Fluid Economy !!
My friend John Vogel does private analysis of the employment numbers
every week and shares the results with a few of us. He did a longer
opus this week, talking about the very fluid job picture in the US. If
you add up all the initial jobless claims from 2006 through 2009, the
number is 83,772,000 lost jobs. Yet during that same period we must
have created 81,258,000 jobs, for the BLS numbers to balance. In the
last year (11 months), we saw 21,696,000 initial unemployment claims,
yet we created 25,893,000 jobs.
We have 130 million people working in the US, but that is down from
137.6 million in 2007, and less than were employed ten years ago, in
2000. But that also means some 15% of all workers had to find new jobs
last year, not even counting those who left willingly to go to another
job. I seem to remember that if you count the latter, the number goes
to some 20% of US workers changing jobs each year.
That seemed rather high to me until I thought about my own seven kids,
six of whom are in the workforce. On average for them, 20% change a
year (one job every five years) would be rather low. Admittedly, they
are young, but it does give some credence to the BLS numbers, which
show how fluid the US job market really is.
My deep fear, as we leave this topic, is that we are creating a
structurally unemployed or underemployed class of workers, people with
skills that are not keeping up with the times or who are chronically
undereducated. The McCormick reaper and the tractor put tens of
millions of farm workers out of a job, forcing them to go to the
cities and learn new skills. Who would want to go back to the 1860s,
when the majority of the US population worked on farms? But that was a
time of tremendous upheaval. I think we are facing such a time
ourselves.
Wrapping up for this week, I think the US grows at 2.5 – 3% GDP this
year, with the world doing better and Europe ex-Germany much worse.
Much of peripheral Europe may fall into recession.
source: http://www.johnmauldin.com
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