SHI Update 2/8/17: Occam’s razor

The FEDs Trillion Dollar Balance Sheet
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SHI Update 2/15/17: Economic Soup
February 15, 2017
About 700 years ago, an English Franciscan friar with the name ‘William of Ockham’ penned a problem-solving approach that for centuries has been hailed as genius.   Today it’s often referred to as the “law of parsimony” and, in its simplest form, basically says, “The simplest answer is usually the correct one.”
Of course, we can say it more scientifically: “Among competing hypotheses, the one with the fewest assumptions should be selected.”  But this really means the same thing.
Occam’s razor’ is especially useful when one faces a problem that seems to have no rational explanation.  For example, yesterday, Belgium successfully sold government bonds that mature in 2057 at a rate of 2.30%.  In fact, according to bankers handling the ‘deal’, there were more orders for the 2057 bond than for another bond issue that matured in 2024, permitting Belgium to lower the interest rate on the 2057 bond to 2.3%.  Amazing.
In a world where interest rates have risen – and are expected by many experts to move even higher – what rational explanation could explain why buyers would select an ultra long maturity at such a low yield?   Why would an investor agree to a 40-year maturity at 2.3% at a time when European inflation is approaching 2% – and may go higher – and the 10-year Belgian bond alternative offers about a .65% yield?
Occam’s razor can help.  If the simplest answer is usually the correct answer, what is the simplest answer in this case?   The simplest answer is ultra long-term investors must disagree with the experts.   Said another way, ultra long-bond investors are betting billions of dollars and euros the experts suggesting inflation and rates will rise significantly are wrong.
Welcome to this week’s Steak House Index update.
Remember: The Steak House Index BLOG has its own URL – https://www.steakhouseindex.com/ The reading experience on the site is much better than in the email form. I suggest you click the link and give it a try!
As always, if you need a refresher on the SHI, or its objective and methodology, I suggest you open and read the original BLOG: https://terryliebman.wordpress.com/2016/03/02/move-over-big-mac-index-here-comes-the-steak-house-index/)

Why You Should Care: The US economy and US dollar are the foundation of global economics: our nominal GDP is over $18.8 trillion a year. Is it growing or shrinking? Is it possible to know – before the quarterly GDP releases from the BEA?
The objective of the SHI is simple: To predict the direction of this behemoth ahead of official economic releases. But while the objective is simple, the task is not.
BEA publishes GDP figures the instant they’re available. Unfortunately, it is a trailing index. The data is old news; it’s a lagging indicator.
‘Personal consumption expenditures,’ or PCE, is the single largest component of the GDP. In fact, the majority of all GDP increases (or declines) usually result from (increases or decreases in) consumer spending. Thus, this is clearly an important metric to track.
I intend the SHI is to be predictive, anticipating where the economy is going – not where it’s been. Thereby giving us the ability to take action early. Not when it’s too late.

Taking action: Keep up with this weekly BLOG update. If the SHI index moves appreciably – either showing massive improvement or significant declines – indicating expanding economic strength or a potential recession, we’ll discuss possible actions at that time.

The BLOG:   A strong appetite remains for ultra long-bonds…in spite of the simple fact that a bond’s value moves inversely to interest rate movement.  Meaning, if the experts are right, in the near future a bond trader can buy at a much lower price, and a much better yield, than today’s offerings.  Yet, buying continues.   Sure, a 2.3% yield is higher than ultra long-term yields before the EOY 2016 global yield bump.  But if investors are worried that bond values could continue to erode if global inflation pick ups, they’re actions tell us something else is at work here.
Make no mistake:   According to our two indices – the SHI and the SHCI – our US economy is on solid footing.   As you’ll see below, both readings are quite high. 
As you know, macro economic theory suggests that a sizzling economy is the pre-condition for increased inflation.  And increasing inflation is a pre-condition for rising bond yields and falling bond prices.  Yet, investors continue to snap up billions of dollars and euros of ultra-long term bonds.  Why? 
Yes, once again I will leave this question for a future BLOG.   Today, we have to check in with the steakhouses and see just how hot those grills are!
Ultra-Hot is the answer!   Ultra-expensive steaks are selling like hotcakes!    Check out this weeks SHI:

 

This week both Masto’s AND Ruth’s Chris are fully booked!   With the exception of December, 2016, this has never happened before!  And even the Capital Grille has two unavailable slots.  December aside, this weeks SHI reading of a positive 35 is the highest we’ve seen since … well … ever!

 

 

Now let’s jump to the SHCI.  You will recall our SHCI is a more comprehensive measure of the US economy.   Beyond the SHI alone, which is designed to measure consumer spending, the SHCI weighs 3 components using a rigid, consistent methodology:
  1. The SHI, as it taps directly into consumer spending, is weighted at 60%.
  2. The LMCI, our labor market health barometer, is weighted at 20%.
  3. The ’10/3 spread’ – a barometer of bond market confidence – will also be weighted at 20%.   (However, to ‘right size’ the value in relation to the SHI and the LMCI, we will multiply a positive reading by 10X and a negative reading by 20X.)
As I said in the July 13th BLOG (https://terryliebman.wordpress.com/2016/07/13/steak-house-index-shci-update-7132016/) if all three of our metrics simultaneously achieved floor or peak values, the SHCI can range from a low of negative 22.1 to a positive 104.  Here are today’s readings:
  • UST 10 Year/3 Month ‘spread’:   Tracking the data, weekly ending Tuesday, our latest FRED reading (yesterday) is 1.89%.   This reading is consistent with last month.
  • Labor Market Conditions Index:  The January 2017 LMCI reading released on Monday was a positive 1.3%.   This positive reading is very strong … and gives us 8 months of consistent positive LMCI readings.  (While the reading is positive, indicating labor conditions are improving, a reading of 1.3 is fairly neutral when viewed in historic perspective.   For more details and a great chart, click on this URL:  https://fred.stlouisfed.org/series/FRBLMCI)
Our algorithm for the SHCI this month generates a reading of 18.6 a sizable increase from last month.   Which suggests our economy is improving, growing stronger.  And the likelihood of a recession grows fainter.
Significant increases in sales of expensive steaks are good for our economy.   It reflects both consumer confidence and robust consumer spending.   It would appear the “Trump Effect” is alive and well in the Steakhouse.
  • Terry Liebman

1 Comment

  1. I loved your article.Thanks Again. Really Great.