Disclaimer. After nearly 40 years managing money for some of the largest life offices and investment managers in the world, I think I have something to offer. These days I'm retired, and I can't by law give you advice. While I do make mistakes, I try hard to do my analysis thoroughly, and to make sure my data are correct (old habits die hard!) Also, don't ask me why I called it "Volewica". It's too late, now.

BTW, clicking on most charts will produce the original-sized, i.e., bigger version.

Tuesday, December 14, 2010

It's bad

From Grog's Gamut, an Ozzie political blog, I got these two interesting charts.  He in turn got them here.

The chart shows the percentage change in employment (so comparisons over long periods are possible, even though the US population has tripled over sixty years) with the deepest point of the downturn shown as month zero.  This is the worst post WWII downturn, without any question.  But we already knew that.  What is scary is that the gap between the experience this cycle and most previous cycles is widening.  Yes, employment is rising, but at the rate typical of a moderate downturn not the severe one we had.  And of course, that's because the US has far, far too much debt, which in turn means that housing, which typically rebounds sharply during the recovery, hasn't this time.

The comparison with Australia is interesting though probably not instructive.  For a long time we had a higher unemployment rate than the US.  Now our rate is lower than the US's.  The lucky country, indeed.  Thanks for all our raw materials.  And thank you China.

Sunday, December 12, 2010

Lies, Damn lies, and Statistics

The release of Australia's latest labour force survey was greeted by everybody with euphoria.  The headlines trumpeted a fall in the unemployment rate, and a huge surge in employment.  The digger dollar strengthened and the market rose. 

But all these reactions showed how little people -- including the oh-so-wise shakers and movers -- really understand about statistical processes.  The Ozzie population is around 22 million.  The sample from which these data are estimated is not much over 1200 people interviewed.  So from a small number the statistician has to estimate a much much larger number.  This would suggest fairly wide absolute errors in the data, even if in percentage terms they would be quite small.  And so it is.  Look at the table below:

Movements in seasonally adjusted series between
October 2010 and November 2010

Monthly change
95% Confidence interval

Total Employment
54 600
109 200
Total Unemployment
-19 500
-50 500
11 500
Unemployment rate
-0.2 pts
-0.4 pts
0.0 pts
Participation rate
0.1 pts
-0.3 pts
0.5 pts

- nil or rounded to zero (including null cells) 

Note that total employment is estimated to have risen by 54,600.  In the context of the US, the equivalent jump in employment would be close to 900,000.  That would indeed be a boom.  But the 95% confidence interval gives a range of between zero and 109,200.  We are 95% sure that employment didn't fall, nor that it rose more than 109,200.   That's a big gap, folks.  The markets assumed that the statistics were exact.  They're not.  They a blur, a smudge, a vision seen by a short-sighted person who isn't wearing his glasses.
Unemployment Rate

Now the statistical boffins in Canberra know this.  They would like to have a larger sample so that they could narrow the 95% confidence limits.  But the government is saving money, by keeping down the sample size.  Cretins.  Because the pollies don't understand stats either.  All the statisticians can do is to warn us to use the smoothed trend as the guide, not the seasonally adjusted data.   And note how the trend in unemployment has stopped falling and has started rising.  Gently, but nevertheless it's headed higher.  The RBA has been raising the cash rate.  Mortgage rates have risen even faster.  Loan demand has slumped.  Housing clearance rates (the number of houses offered for auction which are actually sold) have fallen sharply in the two main metropolises.  This indicator is an excellent guide to house prices. The Reject Shop's recent profit warning says that demand is weak.  The savings ratio has gone from below zero to 10%.

Total Employment
Now let's have a look at the level of employment.  Notice that it's above trend.  What normally happens when a time series deviates from its trend is that it snaps back to trend.  You can see how that happened in January 2010.  Employment rose very sharply, only to fall a little in the next month.  Remember: these are the putative centres of a blur.  They are not divinely inspired numbers accurate to the last decimal place.  But the trend is your best estimate to what's going on.

My conclusion  is that the economy is pausing, slowing.  Not to recession, not with China booming and our exports with it, but growth is definitely weakening.  And the economy outside the mining sector is very weak indeed.

Even if your interest in the Ozzie economy and its markets is minimal, the lessons about statistical variance and unreliability are the same in all economies.  And I wonder, when inevitably next month's data are weak, even if the trends are unchanged, will the digger dollar fall and the share market with it?


Wednesday, December 8, 2010


QE2.  No, not the ship, though it's as big as she is.  Quantitative easing.  It used to be called "open market operations".

How does it work?  The central bank -- the Federal Reserve Board ("Fed"), or in Australia, the Reserve bank of Australia (RBA -- difficult, huh?)  buys government stock or quality private sector paper such as securitised mortgages (oh, wait, those aren't quality any more) or good corporate bonds.    It pays whoever it buys them from with a cheque drawn on itself (or, in truth, these days an EFT from its account) to the seller of the paper.  The seller (in fact, his bank) then has additional cash (defining cash to include at-sight deposits at the Fed)   He will have too much cash.  If the yield curve is positive, which it is in most countries now, cash will earn very little (zero in the US, for example) while longer-dated paper (say one or two year governments) will earn a couple of percent, with loans earning even more.  Of course, that's assuming you're willing to make loans and can find sound and willing borrowers, which is a problem right now.  The sound ones aren't especially willing.  But there will be some who are willing to borrow and likely to repay, and the amount of money available to them will have risen while its price will have have gone down.  And that's what the Fed is aiming for.  Because if loans increase, investment in plant and equipment will rise, asset prices will increase as valuation rates fall, and a virtuous cycle of rising demand, employment and output will have begun.

There will be an additional effect.  The supply of US dollars will increase sharply.  This will reduce the value of the US$ relative to other currencies, i.e., the dollar will depreciate.  This will make imports into America more expensive and exports cheaper.  This will add to US demand and US employment.  It will also put upward pressure under prices, and that would be a good thing.  Measured by underlying inflation rates, we are close to deflation.  Deflation in an economy with too much debt is devastating -- it was a key factor in the collapse after the 1929 great stock market crash.  The value of the debt rises in real terms when there is deflation, making repayment harder.  Interest rates can only fall to zero, in nominal terms.  If prices are falling, then in real terms, interest rates are above zero.  Stimulus becomes harder, then as the crisis extends, impossible.

Will it work?  Well, it did before.  In 1933, after nearly four years of a steady downward grind in price levels, wages, employment, industrial production, sales, incomes and GDP, the Fed conducted open market operations.  It bought $2 billion of federal bonds.  In today's money that's less than what's proposed now, though the economy is far bigger.  Within 3 months IP bottomed, within 6 employment started to rise, and the great depression was over.  Prior to that the Fed had tightened monetary policy because it was afraid of inflation(sound familiar?)  In 1937, the Fed tightened policy again, and the government, under pressure from earlier tea-partiers, cut spending and raised taxes, and there was a very sharp downturn.  Neither Palin nor Huckabee or their ilk are intellectual giants.  There's a serious risk that mistake will be repeated, with swingeing cuts to spending.  But, if the Fed has anything to do with it, QE will happen, and my guess is it'll work.  It won't stop the savage structural problem of an economy which saves too little, has borrowed too much, and has far too much debt (and I'm not talking about the government) , but it will resuscitate the patient for a while.  The real risk will come, when as in 1937, they start to withdraw the stimulus.  2013, anyone?