Lumber Liquidators is the largest specialty retailer of hardwood
flooring in the U.S. The company offers premium hardwood
flooring products in a wide variety of domestic and exotic wood,
as well as engineered products, laminates, bamboo, cork, and
accessories. Lumber Liquidators assortment is largely comprised
of proprietary brands including the flagship Bellawood brand.
Consumer & Retail — Specialty Retail MOMENTUM VANISHES IN Q2 PUSHING OUR ESTIMATES LOWER Investment recommendation
We are lowering our Q2 EPS estimate from $0.94 to $0.61,
compared with guidance of $0.59-$0.61 and prior consensus of
$0.90. LL reported a Q2 SSS decline of 7.1% on top of +14.9%
versus expectations of +7%. Total customers invoiced declined
5% yr./yr., the steepest decline in three years. LL did not regain
momentum after difficult Q1 weather as we had anticipated, and
management is blaming macroeconomic factors. The 131 stores
impacted by weather experienced a SSS decline of 13%, with
non-impacted stores -2%. We are lowering our FY14 EPS
estimate from $3.35 to $2.70 on SSS -2.5% on top of +15.8% (we
had previously forecast +6.3%). We still project double-digit sales
and EPS growth over the long term, keeping us BUY rated. Given
consecutive quarterly EPS misses and limited near-term visibility,
we think investors will view LL as a show-me stock over the next
few months. Investment highlights An inventory shortfall accounted for $18MM of Q2’s $47MM
revenue downfall versus our estimate. LL expects quality
assurance-related supply-chain issues to resolve in Q3.
We are reducing our price target from $122 to $100 based on our discounted free cash flow model. This is a long-term target, and reflects our belief that LL’s model of better selection, service, and value should enable it to take market share
The U.S. economy contracted in the first quarter by the most since the depths of the last recession as consumer spending cooled.
Gross domestic product fell at a 2.9 percent annualized rate, more than forecast and the worst reading since the same three months in 2009, after a previously reported 1 percent drop, the Commerce Department said today inWashington. It marked the biggest downward revision from the agency’s second GDP estimate since records began in 1976. The revision reflected a slowdown in health care spending.
Consumers returned to stores and car dealerships, companies placed more orders for equipment and manufacturing picked up as temperatures warmed, indicating the early-year setback was temporary. Combined with more job gains, such data underscore the view of Federal Reserve policy makers that the economy is improving and in less need of monetary stimulus.
The first-quarter slump is “not really reflective of fundamentals,” said Sam Coffin, an economist at UBS Securities LLC in New York and the best forecaster of GDP in the last two years, according to data compiled by Bloomberg. “For the second quarter, we’ll see some weather rebound and a return to more normal activity after that long winter.”
Another report showed orders for business equipment climbed in May, showing corporate investment is helping revive the economy after the slump at the start of the year. Bookings for non-military capital goods excluding aircraft rose 0.7 percent after a 1.1 percent drop in April, according to the Commerce Department.
Demand for all durable goods — items meant to last at least three years — decreased 1 percent, reflecting declines in the volatile transportation and defense categories.
Stock-index futures declined after the figures, with the contract on the Standard & Poor’s 500 Index dropping 0.2 percent to 1,939.1 at 8:55 a.m. in New York.
Economists surveyed by Bloomberg projected a 1.8 percent drop in first-quarter GDP, according to the median of 76 forecasts. Estimates ranged from declines of 0.5 percent to 2.4 percent. The economy expanded at a 2.6 percent pace in the final three months of 2013.
This marked the last of three readings for the quarter. The advance estimate of second-quarter GDP is scheduled for July 30.
The economy will expand at a 3.5 percent rate in the second quarter and average 3.1 percent in last half of the year, according to the median projection economists surveyed by Bloomberg from June 6 to June 11. For all of 2013, the economy expanded 1.9 percent after a 2.8 percent gain in the prior year.
Consumer purchases, which account for about 70 percent of the economy, rose at a 1 percent annualized rate in the first quarter, the weakest pace in five years. The gain, which added 0.71 percentage point to GDP, compared with the previous estimate of 3.1 percent.
The revision reflected a drop in spending tied to health care services. The Bureau of Economic Analysis had estimated that major provisions of President Obama’s signature health care law would boost outlays. A quarterly services survey released this month showed the assumptions were too optimistic. Outlays for health spending actually slowed in the first quarter, subtracting 0.16 percentage point from GDP. The Commerce Department previously estimated those outlays added 1 percentage point to GDP.
Companies boosted stockpiles by $45.9 billion in the first quarter, compared the $49 billion gain previously reported and less than the $111.7 billion buildup in the final three months of 2013. Inventories subtracted 1.7 percentage points from GDP from January to March, the most since the fourth quarter 2012.
Final sales, which exclude inventories, decreased 1.3 percent in the first quarter compared with a previously reported 0.6 percent increase.
Aside from services, consumer outlays on goods also slowed from the end of 2013, rising at a 0.2 percent rate. Demand faltered as the northern and eastern U.S. experienced above-average snowfall from December through February, keeping Americans closer to home.
Since then, households have boosted spending. Cars and light trucks sold in May at a16.7 million annualized rate, the strongest since February 2007, according to data from Ward’s Automotive Group.
The weather earlier this year also hampered production at factories, which had trouble obtaining materials in time. Since then, assembly lines have become busier.
Business investment fell at a 1.2 percent annualized rate, today’s figures showed, compared with a previously reported 1.6 percent annualized drop. Companies reduced their spending on structures at a 7.7 percent pace, and spending for equipment fell 2.8 percent, today’s report showed.
Trade was also a bigger drag on GDP than last estimated. Net exports subtracted 1.53 percentage points from GDP, compared with a prior estimate of 0.95 percentage point.
Improving job opportunities are boosting prospects for the economy. Employers added 217,000 workers in May following a 282,000 gain in April, according to the Labor Department.
Officials at FedEx Corp. (FDX), the Memphis, Tennessee-based operator of the world’s largest cargo airline, are looking for continued economic pickup this year and into next. The company forecast 2.2 percent U.S. growth for 2014 and 3.1 percent for 2015, T. Michael Glenn, executive vice president for marketing development, said on a June 18 earnings call.
“Our expectations for economic growth for the remainder of the year have actually improved somewhat,” Glenn said. “The global economy is recovering from the Q1 setback in the U.S. and slowdown in China and should steadily improve.”
Price pressures remained muted in the first quarter. A measure of inflation, which is tied to consumer spending and excludes food and energy, climbed at a 1.2 percent rate.
Subdued inflation is giving the Fed’s policy making committee room to keep the main interest rate near zero to encourage lending and spur growth. Even so, the Fed announced June 18 that it is paring asset purchases by $10 billion to $35 billion per month, showing that it remains confident that the U.S. economy can make do with lessened stimulus.
The Fed said economic activity “has rebounded in recent months” as the labor market showed improvement and household spending showed signs of rising moderately.
BRUSSELS (Reuters) – Iraq will be foremost in investors’ minds in the coming week as oil price risk has returned to markets, complicating the task for central banks whose policies are beginning to diverge for the first time since the global financial crisis. Renewed concern over inflation
Oil prices neared nine-month highs late last week, touching $115 a barrel, and the rapid advance of militants in Iraq, the second-largest OPEC producer, is destabilising oil markets.
That has implications for inflation in the United States and Europe, as well as Asia’s export-oriented economies that are large net importers of oil.
Investors will be watching a range of data, from German and Japanese consumer prices to first-quarter U.S. GDP, to see how the Federal Reserve, the European Central Bank (ECB), the Bank of England and the Bank of Japan respond.
“Just as oil prices had become increasingly stable, we reckon the risk for an oil price spike is now the highest since the global crisis,” said Christian Keller, an economist at Barclays. “We think a further price spike of 10 to 15 percent from here is not implausible,” he said.
Until now, falling energy prices have partly been responsible for the euro zone’s low level of consumer price inflation, which the ECB considers to be in its “danger zone”.
A rise in the inflation rate would be welcome but economists and the International Monetary Fund believe the ECB still needs to consider U.S.-style money printing to support the bloc.
Euro zone sentiment readings and preliminary purchasing managers’ surveys for June on Monday may give the ECB a sense of how much more help the euro zone economy needs. The recovery from a two-year recession lost pace in April and manufacturing has lost momentum.
Germany’s inflation reading on Friday will give a taste of the euro zone-wide reading that is due the following week.
“Although higher near-term inflation may reduce the likelihood of more ECB easing in the short term, lower economic growth and core inflation down the line would, in fact, support the case for further policy accommodation at a later date,” Luigi Speranza and Gizem Kara of BNP Paribas said in a note.
EU leaders will discuss economic policy at a summit on Thursday and Friday in Brussels.
SOBERING WEEK TO COME?
In the United States, investors will be looking to the third and final reading of U.S. first-quarter GDP figures on Wednesday to see if there is a revision of the 1 percent contraction already printed and which followed disappointing March trade figures.
Federal Reserve chief Janet Yellen cited reasons for optimism about the world’s biggest economy last week, including household spending and a better jobs market. Economists generally agree that the effects of unusually bad winter weather will fade later this year.
Core U.S. consumer prices have risen 2 percent over the last year. If the inflation rate went much higher, it would put pressure on the Fed to consider moving to raise rates.
For now though, the impact of events in Iraq and an oil-driven increase in inflation seem to be less pressing for the Fed.
Yellen said interest rates could stay “well below longer-run normal values at the end of 2016″.
Some of America’s largest money managers interpreted her comments as signalling that rates will remain low throughout 2016.
A speech by Federal Reserve Bank of Philadelphia President Charles Plosser in New York on Tuesday will also be in focus.
“Following last week’s Fed meeting and amid renewed concern over inflation, U.S. news flow might actually be rather sobering,” said Jack A. Bass , wealth adviser with Jack A. Bass and Associates .
There is also talk of additional stimulus in Japan in the coming months. Japan’s annual exports declined for the first time in 15 months in May, hurting the world’s third-biggest economy just as consumption is being crimped by an increase in national sales tax.
This week, much of the focus will be on core nationwide inflation for May and Toyko’s core reading for June as well as the government’s growth strategy, which is under discussion and may be formally decided by Friday.
The Bank of Japan’s monetary stimulus helped weaken the yen by a fifth last year. But the currency has stabilized this year versus the dollar, limiting gains in the value of exports.
Among other big industrialized powers, first-quarter British GDP on Friday will show a different picture.
Economists polled by Reuters expect growth to be revised up to 0.8 percent due to a better showing from construction.
That would bring annual growth to 3.1 percent, the strongest since before the start of the global financial crisis.
The Bank of England could become the first major central bank to raise interest rates since the crisis.
“Markets now more or less fully price in a 25 basis point rate hike by year-end, consistent with our view,” Michael Saunders and Ann O’Kelly at Citi said in a note. “We expect growth will remain strong even while rates rise.”
Ritchie Bros. Auctioneers is the world’s largest industrial equipment auctioneer. The company conducts auctions in more than 110 locations across the globe, including 44 auction sites in North America, Europe, the Middle East, Asia, and Australia. Auctions are 100% unreserved and consist of used and unused equipment that serves a wide variety of industries, such as agriculture, construction, forestry, mining, petroleum, and transportation.
All amounts in US$ unless otherwise noted.
We continue to rate RBA shares HOLD and reiterate our US$20.00 target price. We see a compelling long-term investment case given that RBA’s major capex spend is behind it and organic growth efforts to fill out resulting capacity could potentially result in material dividend upside. Valuation, however, keeps us neutral. Investment highlights
Peter Blake, RBA’s CEO : The US is where management sees the most room for improvement. While a number of issues are impacting US GAP growth, an untenured (less productive) US sales force is perhaps the biggest. Other geographies are more or less operating to plan. Management is increasingly looking to the rental companies as prospective sources of new GAP. Adding a former rental company executive to the Board in June was a nod in this direction.
Separately, RBA released Q3/13 GAP of $790 million (-7% y/y), below our $860 million estimate. On a LTM basis, GAP is down 6%, reflecting the sales force productivity and macro issues mentioned above. We cut our Q3/13 EPS estimate to $0.10 from $0.14 as we incorporate the lower than expected GAP and build in severance as part of some restructuring. Model changes & valuation
We take our 2013E EPS lower by 8% to $0.68, 2014E lower by 19% to $0.81, and introduce 2015E of $1.00. RBA trades at 25x 2014E, above the comps group trading at 19x. Increasing GAP and ROIC could potentially get us more constructive on RBA shares
The Apprentice Millionaire Portfolio ( available from amazon.com) sets three criteria in selecting investments :
1) forecast for the economy THEN
2) select the sectors to benefit from that forecast And Finally
3) in your own and the Jack A. Bass Managed Accounts, select the stocks that will do best in the selected sectors.
So, first ascertain :
Where are the most important economies ( U.S. and China ) headed in the next 12 to 36 months ?
China’s economy showed fresh signs of resilience in August, with key trade data pointing to a sustained strengthening in global demand for goods from the country.
Exports continued to gather steam, rising 7.2% in August from a year earlier, according to data released Sunday by the General Administration of Customs. This was up from a 5.1% rise in July and a contraction of 3.1% in June. Imports rose 7.0% from a year earlier in August, down from 10.9% in July.
The overall picture was of a Chinese economy benefiting from progressive strengthening of demand in the U.S. and other key export markets. China is also continuing to stock up on raw materials for its industrial sector. “China’s back,” said Stephen Green of Standard Chartered Bank. “It won’t be a strong recovery but it’s increasingly clear we’ve bottomed.”
AND the reason is U.S. growth leading to increased demand for products from China.
One sector that benefits is shipping because that increase will be moved by ships.
AFP/Getty ImagesEnlarge Image
China’s trade surplus strengthens in August on strong exports driven by U.S. demand.
August’s trade numbers are the latest in a series of positive data releases, after overseas sales and factory output in July showed signs of improvement.
There are still some questions surrounding the sustainability of the current upswing.
Rising wages and a stronger currency dent the competitiveness of China’s exports. Beijing’s recent moves to slow lending growth — after years of credit-fueled economic expansion — could curtail investment and imports.
Still, two months of stronger data has increased optimism that the government will be able to hit its full-year target for gross domestic product growth, which stands at 7.5%. It also reduces the chances that leaders will introduce a major new stimulus policy.
Economists have responded to the signs of strengthening by edging up their growth forecasts. J.P. Morgan now expects 7.6% year-on-year growth in the third quarter, up
their growth forecasts. J.P. Morgan now expects 7.6% year-on-year growth in the third quarter, up from a previous forecast of 7.4%, which points to an acceleration from 7.5% growth in the second quarter.
China’s trade surplus widened, with the difference between exports and imports growing to $28.5 billion in August, up from $17.8 billion in July, marking its highest level since January.
Caterpillar announced plans to purchase $1 billion of its own common shares under an
accelerated stock repurchase transaction. In April, the company announced a similar $1 billion transaction, which was
completed in June. Repurchasing an additional $1 billion of CAT stock in Q3/13 will bring CAT’s total 2013 stock repurchases
to $2 billion. In February 2007, the Board of Directors authorized the repurchase of $7.5 billion of CAT stock, and in December
2011, the authorization was extended through December 2015. Through the end of Q2/13, $4.8 billion of the $7.5 billion
authorization was spent. Pursuant to the accelerated stock repurchase agreement, CAT has agreed to repurchase $1 billion of its common stock from Societe Generale, with an immediate delivery of approximately 11 million shares based on current market prices.
The final number of shares to be repurchased and the aggregate cost to CAT will be based on CAT’s volume-weighted
average stock price during the term of the transaction, which is expected to be completed in September 2013.
Last week, CAT announced its Q2/13 results and reduced its outlook as dealers draw down inventories. CAT reported Q2/13 revenue of $14.6 billion (-16% y/y) compared with the consensus estimate of $14.9 billion, while EPS was $1.45 (-43% y/y) below the consensus estimate of $1.70. CAT reduced 2013 guidance on a more significant reduction in dealer machine inventory than originally expected, not due to a change in market expectations. For 2013, CAT now expects revenue of between $56 and $58 billion and EPS of $6.50 compared to $57 to $61 billion in revenue previously and EPS of $7.00. CAT’s retail sales of machines in North America declined 10% y/y.
This is the seventh consecutive month that it was in negative territory since April 2010.
COMPANY DESCRIPTION: Canadian Pacific Railway, recognized internationally for its scheduled railway operations, is a transcontinental carrier operating in Canada and the US. Its 14,000-mile rail network serves the principal centers of Canada, from Montreal to Vancouver, and the US Northwest and Midwest regions. CPR feeds directly into America’s heartland from both coasts, and alliances with other carriers extend its market reach throughout the US and into Mexico.
All amounts in C$ unless otherwise noted.
30% increase in normalized EPS projected
We expect the strong operating ratio (OR) improvement train to continue to roll along in Q2/13, propelled by cost cutting benefits. We project roughly 30% normalized EPS growth (i.e., excluding the $0.25-0.30 EPS strike hit in Q2/12), driven by a 71.8% OR (much better than the 77.8% in Q2/10, the last normal Q2). OR gains should continue to come from headcount reductions, yard closures and other cost improvement efforts. Forecast tweaked lower on volume performance, but still very strong
We cut our forecast volume modestly due to weak volumes in Q2/13. We continue to expect good volume growth, but widespread Q2/13 volume weakness in many categories plus potentially slower emerging market commodity demand makes us a bit more cautious on CP volumes.
We continue to model very strong short- and long-term EPS growth for CP, powered by the company’s drive to improve its OR to the mid-60% range. We continue to model a 65% OR in 2015, consistent with recent comments by CEO, Hunter Harrison.
We cut our target C$3.00 to C$134.00 due to our lower forecast. Our valuation multiple is unchanged.
Maintaining HOLD as we think much of the growth is in the stock
We like the CP EPS growth story and reflect the very strong growth potential through our continued use of a premium valuation multiple of 10.0x EV/NTM EBITDAR (10.0x Q1/14E EV to Q2/14E – Q1/15E EBITDAR).
Our one-year valuation multiple is 1.0x above our normal valuation multiple to reflect the strong share price appreciation potential over the next 2-3 years. Our multiple is referenced against our estimate of a normal period target (our 3-year target) discounted back at our estimate of CP’s weighted average cost of capital (9.3%).
However, we continue to rate CP a HOLD because we don’t see compelling share price appreciation potential in the next year from current levels.
The Great Reflation is a non-political, historical breakdown of inflation, monetary and fiscal policies, interest rates, and long-wave economic theory. It was completed in 2010 and made several predictions on the U.S. economy that have turned out to be correct so far.
Boeckh, former publisher of the Bank Credit Analyst, delves into past financial manias, asset inflation bubbles, asset allocation for the aftermath, the U.S. dollar decline, commodities, and the monetary future of the stock market and the U.S. economy.
Here is a summation of Boeckh’s observations:
1. The global financial system will always remain flawed and subject to price inflation and bubbles, so long as it is based on fiat paper money.
2. Before 1914, most Western countries had a monetary regime that legally restricted central bankmoney creation based on its holdings of gold.
3. Average interest rates fell throughout the 100 years leading up to 1914.
4. In the absence of a financial system based on discipline and restraint, all anchorless fiat money systems (especially the U.S. economy) are destined to suffer inflation and instability.
5. Investors will be playing cat-and-mouse with the Federal Reserve for years to come—a problem caused by excessive private and public debt.
6. Deleveraging of the private sector bodes well for the transition process to the next long-wave cycle (2015+).
7. If the U.S. economy can’t help reduce the debt-to-gross domestic product (GDP) ratio in a timely manner, investors will face a public-sector debt supercycle larger than the post-1982 private-sector supercycle.
8. In the short term, deficits and extreme monetary expansion help the private sector repair balance sheets, but they cannot raise the standard of living for the average person.
9. The real total return of the S&P 500, deflated for inflation, is remarkably consistent over a long period of time.
10. Tactical asset allocation is the key to wealth creation and capital preservation.
11. In a world of economic fragility, investors want stability in the U.S. dollar, but the long-term outlook is bearish.
12. Gold is a crowded trade, but it’s useful as an insurance/inflation hedge in portfolios. Gold is an emotional purchase. Financial/investment demand for gold differs greatly from consumption.
13. Long-term returns from commodities as an asset class are unreliable and they trade in manias.
14. Historically, rising fiscal burdens hasten the demise of empires. The U.S. economy can chart a positive new path, but only with the removal of the political stalemate of vested interests.
15. There will likely not be any effective reform of the global monetary system anytime soon. Greater price inflation is coming.
16. The stock market has proven it does well following long-wave troughs after major financial crises.
17. The long run in this investment world no longer exists. Wealth preservation and portfolio safety are critical.
18. The music has started playing again, but there aren’t enough chairs for when it stops.
The U.S. economy has been consistently swept away by asset bubbles and financial crises, and Boeckh clearly demonstrates how monetary policy so powerfully influences cycles with changes in interest rates and price inflation.
Looking at the data and tables presented, the inflation-adjusted long-term uptrend in the stock market (since 1929, including dividends) averages just under seven percent annually. This is littered with long periods of extreme undervaluation and overvaluation.
Boeckh’s best advice is to employ “tactical stock market reallocation” to continually adjust your exposure to equities as monetary policy perpetually changes the inflation/deflation cycles experienced by the U.S. economy.
English: Portrait of Milton Friedman (Photo credit: Wikipedia)
The Japanese are rapidly coming to their own Endgame, the end of their ability to borrow money at interest rates that are economically rational. If interest rates on Japanese bonds rise to a mere 2.2%, 80% of tax revenues will go just to pay the interest on their debt. At a 245% debt-to-GDP ratio, they are in desperate straits, and they know it. And desperate times call for desperate measures.
To get to where they want to go, to grow their way out of their deflationary problem, the Japanese need both inflation and real growth. Real growth can come from massively increased exports, and inflation can even come from an increase in export prices. Both results can be obtained by weakening the yen. As I have shown, they need to devalue the yen by 15-20% a year for many years in order to break through to the other side.
That should be easy, at least in theory. Inflation, Milton Friedman famously said, is “always and everywhere a monetary phenomenon.” If you want to create inflation and devalue your currency, just print more money. A second shift in the print shop is in order, and if that doesn’t produce the desired results a third shift can be arranged, and then you can run full tilt on weekends. And soon maybe it will be time to build another print shop.
But that is the theory. In practice it may be harder for Japan to grow and generate inflation than it might be for other major nations. Today we’ll focus on Japanese demographics. . The forces of deflation will not go gently into that good night.
The Demographics of Doom
Creating inflation is the goal, but Prime Minister Abe and Bank of Japan Governor Kuroda face a very difficult task. Unlike in Zimbabwe, Argentina, and a host of other countries with defunct fiat currencies, in Japan it is not simply a matter of racking up untenable amounts of debt and then printing tons of money. If it were that simple, inflation would be rampant in Japan, for the Japanese have borrowed more than any country in modern history (relative to their size). And while their efforts to create inflation have been futile, it is not for lack of trying: the Japanese have been actively pursuing quantitative easing for many years. Carl Weinberg of High Frequency Economics, writing in the Globe and Mail, gives us a very succinct summary of the Japanese dilemma:
The National Institute of Population and Social Security Research projects that Japan’s working-age population will decline over the next 17 years, to 67.7 million people by 2030 from 81.7 million in 2010. We select 2030 as the endpoint of today’s discussion because almost all the people who will be in the working-age population by 2030, 17 years from now, have been born already. Immigration and emigration are trivial. The 17-per-cent decline in the working-age population is a certainty, not a forecast. It averages out to a decline of 0.9 per cent a year. In addition, these official projections show a rise in the population aged over 64 to 36.9 million in 2030 from 29.5 million in 2010. If the labour-force participation rate stays constant, we estimate the number of people seeking work in the economy will fall to 56.5 million by 2030 from 65.5 million today and 66 million in 2010.
What happens when a nation’s population declines and the proportion of working-age people decreases? In the first, simplest, level of analysis, the production potential of the economy declines: Fewer workers can produce fewer goods. This does not mean GDP must decline; productivity gains could offset a decline in the labour force. Also, an increase in the labour-force participation rate could mute the effect of a declining working-age population. However, even if the labour force participation rate were to rise to 100 per cent by 2030 from 81 per cent today (which it cannot, because some people have to care for the old and the young, and some are disabled or lack adequate skills or education), there would be fewer workers available in 2030 than there are today.
With fewer people working, the burden of servicing the public-sector debt will be higher for each individual worker. We project that the debt-to-GDP ratio and the debt-per-worker ratio will grow unabated over the next 17 years and beyond. Also, the rise of the ratio of retired workers to 32 per cent of the population from 23 per cent means that people who are still working in 2030 will have to give up a rising share of their income to support retirees. The disposable income of the declining number of workers will fall faster than the decline of production and employment. Overall demand of workers will decrease – with their disposable income – faster than output for the next 17 years at least. Demand will also fall as new retirees spend less than in their earning years.
Based on demographic factors alone, the decline of aggregate demand between now and 2030 will exceed the decline of output, creating persistent and widening excess capacity in the economy. Prices must fall in an economy where slack is steadily increasing. In addition, advancing technology will likely increase output per worker in the future. With overall demand and output falling, productivity gains will lower labour costs and add to downward pressure on prices. Disinflation and deflation are the companions of demographic decline.
Andrew Cates, an economist for UBS, based in Singapore, published a penetrating study on the relationship between inflation and demographics this week. He notes that countries with older populations tend to have lower inflation. That is not what the textbooks suggest, but it’s what the data reveals:
Since ageing demographics will now start to feature more prominently in the outlook for many major developed and developing countries this is clearly of some significance for how inflation might evolve from here. By extension it could be of greater significance for monetary policy settings and the broader outlook for global growth and financial markets as well.
Let’s first look at the evidence. In the chart below we show average inflation levels over the last 5 years plotted against the 5-year change in the dependency ratio. The latter is the ratio of the very old and the very young to the population of working age. A shift down in that ratio implies that the population in a given country is getting younger (and vice versa). The chart therefore shows that those countries that have been getting older in recent years have typically faced very low inflation rates and, in the case of Japan, deflation. In the meantime those countries that have been getting younger in recent years, such as India, Turkey, Indonesia and Brazil, have faced relatively high inflation rates.
Abe has proposed an economic reform package comprising “three arrows”: aggressive monetary easing, labor and other structural reforms (which will be politically very difficult to achieve) intended to induce private-sector growth-promoting investment, and a flexible fiscal policy (whatever that means – I guess, since it’s “flexible,” it means whatever he decides it means). He gave a speech this week on those reforms, and the market promptly threw up. The “reforms” he touted were more of the same old same old. At dinner on Wednesday night, Art Cashin modified the opening line from the old Longfellow poem: “I shot an arrow into the air… and it landed in my foot.”
Not that I think Abe had much choice. He has a critical election next month. Touting a policy that allows employers a freer hand in firing workers is not likely to win over many voters, but he must get serious about reform if he is to have any hope of limiting the disaster he faces.
Banzai! Banzai! Banzai!
The Japanese are charging the deflationary battle lines, crying “Banzai!” This attack is all or nothing. I think the Japanese are offering us investors their flank. This week’s action in the markets showed us that this battle will not be one-sided. It will often get ugly. But I want to keep reiterating what I have been saying for a long time: shorting the Japanese government is the trade of the decade. That is the largest position in my personal portfolio, and it is going to get larger, as I intend to fully swap the mortgage I just took out this week into yen. As I said to Tom Keene this morning, it is my intention (more accurately styled as hope) to let Abe-san and Kuroda-san pay for a large chunk of my new apartment through their policy of destroying the yen. I have to admit to feeling good when the yen backs up like it has this week, since that gives me a chance to get my trade on at a better entry.