The Hutch Report

Vancouver Real Estate – Is the bubble deflating?

By | Economics, Politics

“It is different this time,” “This is the place everybody wants to be,” has been the talking points when referring to the impressive rise of Vancouver and its real estate market. Unfortunately all markets that experience a rapid escalation of asset prices, as we have seen in Vancouver, eventually experience a painful contraction whereby, as macro investor Raoul Pal puts it, “The big uglies come out.” Are we starting to see what those big uglies are in the Vancouver real estate market?

Vancouver has been the victim of a number of economic events in the world that have culminated in the development of its current dangerous real estate bubble. Central bankers driving interest rates down to historic lows and keeping them there for years, the rapid rise of China’s economy along with the massive number of its newly printed Chinese millionaires, the rise of corruption in China, the exodus of this corrupt money along with Chinese government efforts to reign it in, are just a few of these events.

Life in Vancouver, where the talk of real estate riches and Vancouver suddenly becoming the place to be, has become the favourite subject among its residents, although they may not be aware that other regions in the world have experienced the same impact and will experience the same result. 

Top residential real estate brokerages in the US have been promoting US homes to investors in China for years. Brokerage firms in Canada, Australia, New Zealand, and other countries have done the same. They have set up units in China and have partnered with Chinese real estate portals, such as However, one place where the real estate bubble is most prevelent is in China itself. According to a recent report by Bloomberg, a fifth of China’s housing is empty. That’s 50 Million homes! 

This is what happens when rampant speculation in a market is not contained. Unfortunately when there is money to be made people disregard the splitting hangover that the all night party can bring. 

So what has the impact been in Vancouver?

For too long Vancouver disregarded the longer term risks and turned a blind eye to the massive amounts of corrupt speculative money that was pouring in from China. The low interest rates fuelled the building in Vancouver in order to satisfy the insatiable thirst for Vancouver real estate. (This was pretty much the same story in Australia and New Zealand). There was a rapid rise in prices pushed up by Chinese buyers, in addition to Vancouver residents rushing into the market for fear of missing out. The result was Vancouver real estate became quickly unaffordable to many of its own residents. 

Only recently has the government tried to halt the rise. In 2016, Vancouver became the first Canadian City to collect an empty homes tax, charging one per cent of the home’s assessed value if the owners are not living in it or are renting it out for less than six months. In addition, the government also imposed a 20% foreign property buyers tax.  

Elsewhere, New Zealand’s parliament banned many foreigners from outright buying existing homes in the country – a move aimed at making properties more affordable. New Zealand is also facing a housing affordability crisis which has left home ownership out of reach for many.

Canada, New Zealand and others are not the only ones taking measures to reign this in. China has begun cracking down. Over the last decade, an estimated $3.8 trillion in capital has left China. Net foreign direct investment over the same period of time has amounted to $1.3 trillion, leaving the country with a net loss. To reduce capital flight, the Chinese government has developed a complex system of capital controls, such as limiting transfers of $50,000. However, that has not stopped the Chinese from being creative. The CEO of a Chinese company moved $750,000 from China to Metro Vancouver for a real estate deal with the help of nine strangers who each brought $50,000 into Canada for “tourist purposes,” according to a B.C. Supreme Court judgment.

But in spite of these controls the damage has been done and now increasing interest rates may just be fuelling the fire as the news starts to trickle in. 

According to economists at the Royal Bank of Canada, owning a home in Vancouver is the most unaffordable it has ever been in any Canadian City. In fact, they found affordability to now be “at crisis levels” where it would take a record 88.4 per cent of one’s income to cover ownership costs. Statistics Canada reported that, “Credit market debt as a proportion of household disposable income increased to 169.1 per cent as growth in debt outpaced income. In other words, Canadians owed $1.69 in credit market debt for every dollar of household disposable income.”

Credit reporting agency TransUnion released data showing that Vancouver residents have the highest debts among those who are in major cities, owing an average of $38,753 in non-mortgage, consumer debt through the first quarter of 2018.

Vancouver residents, and Canadians in general, are growing increasingly anxious about their ability to handle higher interest rates, with a new survey showing a rising proportion of consumers fear they will be pushed over the brink. Rightly so, they are concerned mostly about their high-ticket items such as a mortgages and car loans.

As we began this article, the explanation for Vancouver’s real estate rise was its attraction as a city, at least according to many of its residents, its natural beauty and idyllic west coast location. Although in my opinion this is true (considering it is my home town) to a point. There is a difference between speculation and purchasing a home to live in. The first clue that we were dealing with speculators, as is the case in China, should have been the number of empty houses and condos in Vancouver (which was the reason the city eventually created the empty homes tax). 

What has been the effect of these controls on speculators?

Vancouver is now ranked as the worst place in the world for luxury homebuyers seeking a return on their investment, according to a global survey of 43 “prime residential” cities. The Knight Frank Prime International Residential Index found that, while luxury property prices globally were up an average of 4.2% in the third quarter, compared with the same period in 2017, they fell 11.2% in Vancouver, where luxury home sales have tanked. No other Canadian city made the list, and Vancouver ended up ranked No. 43.

For those in Vancouver who refuse to believe bubble talk and believe that the Chinese will keep purchasing and supporting the real estate market for years to come, they may want to rethink that. Beijing has warned of its zero tolerance for dual nationality. Now some foreign citizens who held on to their Chinese identity documents fear the consequences of returning, according to South China Morning Post. In addition, it is hard to believe that the Chinese will be rushing to give up their Chinese citizenship at a time in history when China promises to be the next great economic powerhouse. 

The problem with living through a bubble is often the most vulnerable get hurt, as we saw very clearly during the housing bubble and financial crisis of 2007 in the US. The same is most likely to be true for the Vancouver residents that extended themselves purchasing overpriced real estate that they could ill afford. The international speculators will move on as they continue their worldwide search for return. As in other locations, it is likely that they will not hang around long enough to see the real damage that remains once all the air has been taken out of the bubble. 

The Hutch Report

Understanding the Face of China

By | Economics, Politics

The current Trump trade war with China and the fact that The Shanghai Composite Index is off roughly 24% for the year has placed a lot of the recent news focus on China. However, understanding the Chinese takes much deeper digging into the Chinese mindset as opposed to just looking at current economic numbers. The Trump administration strategy towards China may produce some short term benefits in terms of public support but the Chinese are working on a much longer timeline with which to accomplish their goals.

The best way to understand China is to be there and speak with those with whom we have business relationships, which is exactly how we gained the following insights.

In order to get to where China is today, they required expertise that they didn’t originally have. According to Professor Paul Gillis, a former head of PwC in China turned academic at Peking University’s Guanghua School of Management, and now the pre-eminent foreign analyst in China’s accounting industry, the then big eight western accounting firms clearly saw the opportunity developing in China back in the 1980s. 

“They began building up representative offices to advise foreign firms entering China, at first often working out of hotels. By 1992, they had won the right to audit, working with Chinese partners, and were helping to develop China’s accounting standards. They pulled in all manner of outside experts to help them understand the country.”

The domination of Chinese accounting by four foreign multinationals soon became a source of annoyance in the official halls of Beijing. Paul Gillis wrote that by 2006, Ding Pingzhun, director-general of the government-aligned Chinese Institute of CPAs (CICPA), spoke of the Big Four as firms that “lord themselves arrogantly across China”. 

These firms indirectly and or directly have under their tutorship approximately 60% of the Corporate sector in China. Because of this China knows that the US is intimately familiar with China’s business internal operations (shadow banking and corruption) and thinks they may be using this knowledge to form policy to secretly undermine them and weaken them.

For this reason, China believes that the US has been planning this attack using tariffs since 2000 from the Republican administrations. The expected George W. Bush to implement tariffs during his Presidential administration, however, the attack on New York on 9/11 most likely derailed the initial opportunity. The 2008 crash most likely took away the second opportunity for Bush to apply any meaningful tariffs against China. By the time Trump came along and implimented this strategy the Chinese were not surprised as they had been expecting such a move for some time. 

The Chinese understand the recent US moves to reduce corporate taxes in order to repatriate money offshore and induce these companies to return their manufacturing bases back to the US. The Chinese also realise that an agreement between North Korea and South Korea (with the US brokering) could create a much cheaper labor base. The threat is that this could take away a lot of labour intensive industries from China.

They believe that the tariff program was put in place to try and weaken or slowdown China’s growth in manufacturing and thus their world influence. It is not a secret that China has been going after markets in the Middle East, Africa and Central America spreading their influence in order to breakaway from any stranglehold that the US may currently have on them. In addition, to facilitate this in the future China has taken on the massive development of the One Belt, One Road initiative which if successful will change the face of international trade. 

China is playing on a much longer timeline so they are prepared for some pain and suffering. In China, Xi has now solidified his position for life. China knows that the US changes party power every 4 years and is betting that the democrats get back in and reverse the Trump plan.

In order to deal with the Chinese one has to understand some important character traits. 

Of all the idiosyncrasies of Chinese culture, the concept of “Face” is perhaps most difficult for Westerns to fully grasp. And because “saving face” is such a strong motivating force in China, it’s also one of the most important concepts in understanding the Chinese Mind. It goes back centuries and appears in many Chinese sayings and proverbs. 

“Men can’t live without face, trees can’t live without bark.”

(ren hou lian, shu hou pi)

“A family’s ugliness (misfortune) should never be publicly aired”

(jai chou bu ke wai yang)

A traditional insult is to say that someone “has no face”.

(mei you mianzi)

Similarly, one of the worst things is to “lose face”.

(diu lian)

The management of “Face” goes much deeper than just impression management (or “protecting and enhancing your ego”) in the Western sense. Although nobody, regardless of culture, wants to look bad or have their ego bruised, the Chinese concept goes beyond the narrow Western concept of face (and is perhaps closer to the Arab concept of “honour”).

While an American businessperson might be respected back home for his frankness and being a “straight-shooter,” he would likely be viewed in China as uncultured, overbearing, and rude.  President Trump’s remarks against the Chinese on the world stage do not, by any means, go unnoticed by the Chinese public.

The Hutch ReportDuring Hu Jintao’s 2006 visit to the US, there were a large number of missteps on behalf of the Bush administration that were believed to be an intentional campaign to make China lose face on the international stage. If this was truly the case, the Chinese have not forgotten. 

The Hutch ReportThe current trade war should be looked at as an economic battle that could drag on for some time and not as a short term tactic on behalf of the Trump administration. They have opened up Pandora’s box. According to a recent article in the Washington Post, the tough tone on behalf of the US effectively ties Xi’s hands. 

“James Zimmerman, former chairman of the American Chamber of Commerce in China stated, 

“Getting the Chinese to the bargaining table should be all about face-saving — not a chest-thumping exercise, Xi has no choice but to stand firm and stand tall.”

Trump’s bravado approach to try to win concessions from Beijing has provoked a public fury that could ultimately derail his efforts. Although the Trump administration believes that a trade war can be won and that they are in a position to win against China, it should be perfectly clear that today’s China is a much stronger adversary on the economic, military and cyber front, than they ever were. If their back is against the wall it will only be a matter of time before “Xi hits the fan.”

The Hutch Report

The Ghostly Budget

By | Economics, Finance, Politics

It appears that the dark halls of the US Military Complex could teach Trump, Cohen and Manafort  a few things about shadow budgets and hiding money.

Anybody reading this may have come across a story that grazed a few pages a year ago. However, surprisingly it didn’t seem to make more noise among the public than it did at the time. The story involved some unsupported adjustments, or spending by the US army that amounted to roughly $21 trillion. That number is not a typo. If true, it would mean that the US army had spent an unauthorized amount that would equal the current sum of the national debt. Even though the story may not have created a very large public disturbance, it did put a few people in the Pentagon into action. We wanted to find out where the trail was leading. 

For those not familiar with the case, it all started when Dr. Mark Skidmore, a PH.D. in economics and Professor and Morris Chair in State and Local Government Finance and Policy at the Michigan State University, was listening to an interview with Catherine Austin Fitts, former assistant secretary of Housing and Urban Development. In the interview as Skidmore explained “Fitts refered to a report that had come out in 2016 by the Office of the Inspector General (responsible for providing some accountability and tracking of financial activity of the Federal Government).” The report indicated that in fiscal 2015, the US army (with a budget of roughly $122 billion) had adjustments of $6.5 trillion. Because of Dr. Skidmore’s experience and knowledge base, he had some serious doubts about the quoted figure and assumed they must have meant $6.5 billion. He looked at the report himself and to his surprise found that it was not an error. 

This prompted Dr. Skidmore to suggest to Fitts to investigate the issue further.  So during the summer, two MSU graduate students searched government websites, especially the website of the Office of Inspector General (OIG), looking for similar documents dating to 1998. What they found was far beyond what they expected to find. They found documents indicating a total $21 trillion in undocumented adjustments over the 1998-2015 period, of which $11 trillion were directly linked to the US Army.

Dr. Skidmore’s work was able to show that there was something very broken within the budget process. By October 5, 2017 they suddenly discovered that the link to the original OIG report “Army General Fund Adjustments Not Adequately Documented or Supported” of July 26, 2016 had been disabled. Within several days, the links to other OIG documents that had been identified in their search were also disabled. However, Dr. Skidmore and his team had the foresight to copy the July 2016 report and all other relevant OIG-reports in advance and re-post them (The original government documents and a report describing the issue can be found here).

On December 7, 2017, Pentagon officials announced that the Defence Department was beginning the first agency wide financial audit in its history, 

By June 2018, Dr. Skidmore wrote the following update:

“In late May 2018, a graduate student at Michigan State University found on the OIG website the most recent report for the DoD, which summarizes unsupported adjustments for fiscal year 2017. However, this document differs from all previous reports in that all the numbers relating to the unsupported adjustments were redacted. That is, all the relevant information was blacked out.”

So is this situation just over exaggerated with hyperbole and blacked out documents for more dramatic effect? Governmental departments are extraordinarily inefficient organizations. It often requires a number of documents to be signed off before one can order some additional pencils. 

Could such an inefficient department have the smarts and tools to be able to disguise such a massive amount of money from the taxpayers eyes? Well here are some other incidents which shows they never stop short of giving it their best try. 

December 5, 2016, The Washington Post reported that the Pentagon had buried an internal study that exposed $125 billion in administrative waste in its business operations amid fears Congress would use the findings as an excuse to slash the defence budget.

February 5, 2018, a leading accounting firm said in an internal audit obtained by POLITICO, that one of the Pentagon’s largest agencies couldn’t account for hundreds of millions of dollars’ worth of spending, (curiously just as President Donald Trump was proposing a boost in the military budget.)

On August 13, 2018, President Donald Trump signed a military budget boosting the Pentagon’s spending by $82 billion in the next year—a spending increase that dwarfs the entire military budgets of most other nations on Earth. (Russia, for example, will spend an estimated $61 billion on its military this year). With the increased spending included in this year’s National Defense Authorization Act (NDAA), the Pentagon will get to spend more than $700 billion next year. The budget hike was a priority for Trump and was approved by Congress as part of a March spending deal that saw spending on both defense and domestic programs hiked by about $165 billion—smashing through Obama-era spending caps.

On September 17, 2018, it was reported that the Pentagon had massively overestimated, for the second fiscal year in a row, how much its new retirement system would cost.

All that is required is a quick search of the Pentagon and their funding requirements to discover that this is a game that has gone on for a long time. There seems to be a budget for some and a black budget for others in the government.  In the end, it is the taxpayers that are flipping the bill for all the spending. In a Dec. 8 Forbes column that he co-authored with Laurence Kotlikoff, Skidmore said the “gargantuan nature” of the undocumented federal spending “should be a great concern to all taxpayers.”

The fact that these previous reports along with the revelations of Dr. Skidmore and Catherine Austin Fitts have not caused people to become enraged is surprising. This just seems to show that the general public view towards the current levels of greed and corruption are still complacent.  Although the US dollar as a reserve currency may allow the government to get away with many of their spending habits and shadow budget operations for the moment, the day it’s removed will cause some serious repercussions. 

We can already see many signs of the international community getting frustrated with strong arm tactics by the US and adjusting appropriately in order not to be held hostage anymore by the US dollar reserve status.

Reuters recently reported, 

“The U.S. dollar’s share of currency reserves reported to the International Monetary Fund fell in first quarter of 2018 to a fresh four-year low, while euro, yuan and sterling’s shares of reserves increased.” 

It is no longer a matter of if, but when.

The Payments War: Who will the winner be?

By | Economics, Finance, Technology

When mentioning Payments War, some people think of Shopping Wars and fist fights at Walmart on Black Friday. This article is not about that. The Payments Wars are actually multiple wars. A war on cash. A war for your shopping behavior and data. A war for your wallet. These wars are raging both online in the digital world as well as offline in the analog world and the two worlds are converging as combatants vie for cashless digital transactions for offline payments. Why should you care? Every time you buy something, whether you like it or not, it is over you and your data for which the battle is being fought. Your payment behavior and your payment data is what they are after. How will you pay and which platforms will be used? Will that be cash, credit card, debit, PayPal/Venmo, Square, Bitcoin and other cryptocurrencies, Apple Pay, Samsung Pay, Amazon one-click payments, Visa, Mastercard, Discover, Amex or even a credit line offered at the time of checkout?

The Hutch Report

Many may not realize this war going on right before their eyes each and every day as they buy their coffee, their lunch, their gas, groceries, electronics and anything else. And it has been going on for a long time. The winner wants to be the master of how consumers pay for things. As hinted above, the reasons are several-fold. One is, that at scale, there is money to be made processing payments and slicing a few cents or more off of each transaction which amounts to massive amounts at scale. To put this in some context here were the quarterly revenue volumes reported by a few of the combatants in the summer of 2018

A 2017 report by Statista estimates that total payments revenues, which were 1.6 trillion US dollars in 2016 will reach 2.2 trillion US dollars by 2021. That is what the processors are earning on payments. The overall payments volume, what PayPal calls TPV or Total Payment Volume, is a much higher amount.

These massive volumes of payments occur each day online, in stores around the world, at market places, peer to peer, travel and transportation, domestic services, credit payments, business to business payments, cross border and international payments… in other words, there is a lot. We were unable to find exact figures for the total value and number of transactions comprising annual payment volumes including cash and non-cash world-wide, but you can easily see that this number is easily in the trillions. Effectively it would probably be very close to the sum of the GDP (gross domestic product) of all countries – in other words the Gross World Product which is currently near $80 Trillion dollars a year.




Alibaba, the world’s largest (454M buyers) online market place processed $547 Billion of payments in China alone in 2017. So while $547B is large, it is a small fraction, less than 1% of world GDP … or total world payment volume.










Secondly and some may argue even more valuable than the processing fees, generating revenues for payments companies such as the ones mentioned above, is the data that can be collected on consumer and merchant behavior.  The Hutch Report recently chronicled how data is quickly becoming the new biological nerve gas. The credit card associations assign a merchant category code to each merchant and this code corresponds to the type of business or service the company offers. But this is just the tip of the iceberg, data is collected for each transaction on the amount, the location, the date and time, the type of transaction (purchase, refund, withdrawal, deposit, etc), the type of account, card number, identity of the card acceptor (eg. merchant), information on the terminal used for payment, and much more. Apple already has over 450 million credit cards on file related to iTunes, the iOS Appstore, and Apple TV. In addition to knowing what media you consume, with Apple Pay, they will know even more about you. In addition to advertisers and the merchants themselves, payments data is also super interesting to investors and market speculators. Investors and speculators will go to great lengths to collect data in order to build an edge for themselves. There are now even companies such as RSMetrics that produce and sell aerial imagery of retail outlet parking lots and production facilities. Payment data is much more granular and refined. In addition, the Government also loves digital data, particularly digital cash because then they can completely monitor it, control it, and even charge negative interest rates quite easily if they so choose.

Given the size of the battlefield, a fragmented regulatory landscape and the existence of a plethora of consumer segments, consumers and consumption types … these wars for how you pay and how your payments data is collected will continue to rage for some time.

The Hutch Report

Anchors Away! Is the US retail boat sinking?

By | Economics

If you put one or more buildings together and form a complex of shops representing merchandisers, add to that interconnected walkways enabling visitors to walk from unit to unit, you get what is known as the great American shopping mall. 

1,500 malls were built in the US between 1956 and 2005, and their rate of growth often outpaced that of the population. They replaced main street and became the epicentre of communities, the foundation of retail economies, and the place for teenagers everywhere to see and be seen.

At the heart of these malls has been the main stays of American retail, the department stores. They have been come to be known as the “anchors.” Every mall has them and it is these stores that make up a large portion of the retail space being dominated by one brand. Without them, there is a very large hole to fill. 

Malls became so popular over the years that everybody wanted in until the point where the market became saturated. “We are over retailed,” according to Ronald Friedman, a partner at Marcum LLP, which researches consumer trends. There is an estimated 26 square foot of retail for every person in the US, compared with about 2.5 square foot per capita in Europe. Howard Davidowitz, famed retail analyst says, “the US has 5 times more retail space per capita than that of Japan, Canada, UK or France.”   

Like anything else, the good times were bound to come to a halt. By the mid-2000s, the decline began slowly. The rise of the internet brought with it the rise of online shopping. The financial crisis of 2007 – 2008 brought a blow to retail that led to a drop in sales and foot traffic at big-brand retailers like Sears, JCPenney and Macy’s that anchored many of the country’s malls. Between 2010 and ’13, mall visits during the holiday season, the busiest shopping time of the year, dropped by 50%. It is clear from the chart below that Sears was badly wounded in 2007 and never recovered, in spite of all the promises of Eddie Lampert to turn the struggling retail giant around.

The Hutch Report

When Sears merged with K-Mart in 2005, the two chains had a total of 3,500 US stores between them. As of May 5, 2018, Sears Holdings operates 894 retail locations under the mastheads of Sears (506 full-line and 23 specialty stores, for at total of 529 locations) and Kmart (365 locations), though after a round of closures announced on May 31, that number will drop to about 820.

In August 2016, Macy’s announced the planned closure of 100 stores, or about 15% of Macy’s store base at the time. 

JC Penney has about 600 mall-based stores and another 400 smaller standalone stores in smaller markets. JC Penny announced and closed 140 stores back in 2017. The King of Prussia Mall is a 2.8 million-square-foot shopping center outside Philadelphia. The 50-year-old complex has more than 50 food venues and a concierge lounge. However, a J.C. Penney department store closed in 2017 as one of the planned closures, created a hole in the anchor-store lineup.

The Hutch Report

The closings of these stores are having an obvious impact on shopping malls across America. The malls that are not able to find an anchor to replace the legacy department stores are seeing their foot traffic dry up as the remaining stores in the mall close up or move, leaving an empty shell. Industry experts say 25 percent of US malls likely will close in the next five years, or about 300 out of the existing 1,100.

According to a recent Credit Suisse report (Credit Suisse US Retail Store Closure Index), 2018 is on track for another peak footage closure year. It shows the US retail industry is tracking to an annualized -59% YOY reduction in store unit closures in 2018 (after hitting an all-time high in ‘17). The closures are skewing toward much bigger box concepts (Toys R Us, Sears, Sam’s). The report states, “We expect elevated closures to remain a primary operational distraction and stock risk for the US retail space for several years.”

The Hutch Report

A report by Cushman & Wakefield, states, “There were nearly 8,500 store closures in 2017, surpassing the number that occurred during the Great Recession. Closures in 2018 are expected to match or exceed that level. Announced store closures have reached approximately 4,500 year to date.” Cushman & Wakefield estimates that this figure will reach over 9,000 this year.

As we have seen many times before, there is also that familiar Gorilla at the front door waiting to make its mark on the brick and mortar market! Jeff Bezos and Amazon are making inroads into the apparel space. According to Morgan Stanley, the e-commerce giant will become the top player of the US apparel industry in 2018, having gained 1.5 percent of market share last year. To date, Amazon trails only Walmart to claim the top spot among other apparel retailers Target, Kohl’s and TJ Maxx.

The Hutch Report

Should this be something for brick and mortar retailers to be worried about? Last year Fitch Ratings published a report that presented how a “hypothetical” rapid rise in Amazon’s U.S. apparel market share could have significant credit implications for existing retailers, REITs and CMBS (Commercial Mortgage Backed Securities) transactions.

“The Fitch shock scenario assumes an accelerated three-year apparel market share shift to as a price-competitive and convenient alternative to traditional in-store purchases. The hypothetical rapid growth in Amazon’s apparel market share to 25% by 2020 could cut apparel retailer margins by around 300 basis points, pushing several retailers toward financial distress. Assuming Amazon’s share gains are concentrated in lower price points, low to mid-tier apparel retailers, including JC Penney, Kohl’s and Dillard’s, would face intense competitive pressure in such a scenario.”

The focus of our article on troubled anchors did not go unnoticed by Fitch. 

“REITs owning regional malls with high exposure to troubled anchor stores and a less diverse tenant base would face heavy cash flow pressure. We estimate that as many as 400 of approximately 1,200 US malls could close or be repurposed as a result of retailer liquidations and square footage reductions.”

Although online has picked up some of this business and will continue to do so, the reduction cannot all be attributable to e-commerce. The desire to grow and get bigger clearly over stepped its boundaries leaving a glut of retail space on the American market. Increasing consumer debt loads in the way of car loans, credit card loans, and student loans are not positioning the consumer to be in any position in the future to come to the rescue. In fact, roughly 10% of employment in the US is in retail. All these additional closing will only put the consumer in a more precarious situation.

The death of the great American shopping mall may be a bit premature, but for the moment it is “Anchors Away” and unless these malls find a way to fill the hole or reinvent themselves fast the future doesn’t look so bright. 

The US Economy – Miracle or Mirage?

By | Economics

The economy of a country is a key talking point of most politicians, and rightly so. If you preside over a strong and growing economy, your political reign is reflected in a positive light.  If the economy of a country is weak as you enter, it will often be deflected and blamed on the predecessors faulty policies. However, there are times when the economy is struggling and the incumbents in power, making changes to improve it, will often point out the most impressive aspects, and mask over the weaknesses in order to convince the voter base that they are succeeding. 

My uncle had a saying, “When your neighbour is out of work, it is a recession; when you are out of work, it is a depression.” Your current personal economic situation will influence how you perceive the strength of the greater economy and what people are saying about it. If you are working in an affluent environment you may not perceive anything is wrong. You have money to go out to dinner, go on vacation or buy that new car you have had your eye on. In other words, your confidence in the greater economy will dictate your spending patterns. There is the counter situation, where you have no work and have essentially stopped looking, yet the financial media and politicians in power are telling you how strong the economy is. If they believe it, it may motivate people to go back to school and adapt their skills to the current job market. If they don’t believe it, they may weather the storm and pull back their spending (Nordstroms is off the table for now, time to head to Walmart). If enough people don’t believe it the true economy will eventually show its true colours no matter what the media and politicians say. 

So what is the true story? There are many economic indicators that are used to track the health of the economy. We looked at these indicators to see if they do provide some kind of clarity or, like many things, it is basically our perception of the current economic state that makes it strong or weak. 

Gross National Income (GNI) and Gross Domestic Product (GDP) are often used to judge the growth of the economy. For most nations there tends to be little difference between GDP and GNI, since the difference between income received by the country versus payments made to the rest of the world tends not to be significant. For example, according to the World Bank,  the U.S.’s GNI was only about 1.5% higher than its GDP in 2016. 

The graph below shows the Real GDP growth rate of the United States from 1990 to 2017 (GDP being the market value of all final goods and services produced within a country in a given period). The Real GDP growth is adjusted for price changes, as inflation or deflation and is chained to the U.S. dollar value of 2009. The Real GDP increased by 2.3 percent in 2017.

The Hutch Report

It takes capital to fund growth and countries will increase their debt loads to increase that growth but if the growth doesn’t come they find themselves in the difficult situation of struggling to pay back the debts. The debt-to-GDP ratio is the ratio of a country’s public debt to its gross domestic product (GDP). By comparing what a country owes with what it produces, the debt-to-GDP ratio indicates its ability to pay back its debts. The US recorded a government debt equivalent to 105.40 percent of the country’s Gross Domestic Product in 2017. Government Debt to GDP in the US averaged 61.70 percent from 1940 until 2017, reaching an all time high of 118.90 percent in 1946 (funding for World War II had something to do with that) and a record low of 31.70 percent in 1981. At the moment, it doesn’t appear to be moving in the right direction.

It should be pointed out that the GDP is made up of Personal consumption + Investments + Government expenditure + Net Exports. Consumption makes up 70% of this GDP number. As mentioned above, if the consumer is in a good mood and confident about the future they will go out and spend. Many will even use credit to charge those purchases and pay another day. However, if they get worried they will pull back their spending and start saving. So in a sense, “So goes the consumer, so goes the economy.” 

The personal saving rate is calculated as the ratio of personal saving to disposable personal income and refers to these strategies of accumulating capital for future use by either not spending a part of one’s income or cutting down on certain costs. In 2017 it amounted to 2.4 percent, as opposed to 10.4 percent in 1960. This was equivalent to just over 384 billion U.S. dollars in the fourth quarter of 2017. In June 2018, the personal saving rate in the US suddenly spiked and amounted to 6.8 percent.

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It is also worth looking at the household debt to income levels of the consumer to know if they are tapped out or not. Households debt in the US increased to 78.70 percent of GDP in the fourth quarter of 2017 from 78.50 percent of GDP in the third quarter of 2017. The households debt To GDP in the US averaged 57.79 percent of GDP from 1952 until 2017, reaching an all time high of 98 percent of GDP in the first quarter of 2008 and a record low of 23.80 percent of GDP in the first quarter of 1952. The consumer, not surprisingly deleveraged after the 2008 financial crisis, however on a historical level they are still indebted well above the average. 

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We won’t even bother looking at retail, as many in the financial media do, to determine the health of the consumer. An increase in Target’s earnings or any other retailer could have a myriad of reasons behind better numbers. Better revenues could be the result of taking advantage of the demise of other retailers (JC Penny or Sears for example). It could be more astute marketing or just better managed. Equally, increased earnings could come from stock buy backs, one off charges or any number of other accounting engineering tricks. 

A much better indicator reflecting the potential health of the consumer are the employment levels. These figures, particularly the unemployment rate, tells us the percentage of the labor force that is unemployed. Since unemployment insurance records relate only to people who have applied for such benefits, and since it is impractical to count every unemployed person each month, the government conducts a monthly survey called the Current Population Survey (CPS) to measure the extent of unemployment in the country. The CPS has been conducted in the United States every month since 1940. In 1994, the CPS underwent a major redesign in order to computerize the interview process as well as to obtain more comprehensive and relevant information. There are about 60,000 eligible households in the sample for this survey. This translates into approximately 110,000 individuals each month, a large sample compared to public opinion surveys, which usually cover fewer than 2,000 people. However, they are essentially polls and we have seen in the recent past how accurate polls can be. 

The chart shows a clear decline in unemployment, yet does it really tell the true story? As campaign Trump said (video below), “Don’t believe those phony numbers.”

That was an impressive speech by candidate Trump. So what do the UI numbers tell us. We took a look at the numbers from the NFP back in June (video below).

The current UI numbers are indicating a very tight labour market. Companies just can’t find the workers. However, normally when that happens a company is forced to become more competitive with other employers and increase wages in order to attract the workers they need. Yet, that doesn’t look to be happening as we see from the chart that wage growth has been pretty stagnant. 

Currently there are roughly 96 million Americans no longer in the workforce. How has that affected the poverty levels? The official poverty rate is 12.7 percent, based on the U.S. Census Bureau’s 2016 estimates. That year, an estimated 43.1 million Americans lived in poverty according to the official measure. According to supplemental poverty measure, the poverty rate was 14.0 percent. This should be considered high considering that it exists in the most affluent country in the world. 

The Hutch ReportPoverty rate in the US as a % of population – US Census Bureau

At the moment, it is not worth looking into the country’s import/export situation considering that President Trump has pulled the country into a trade war. Nobody knows how this will turn out and what the repercussions will come from it.

So in summary the charts show that US GDP growth is relatively stable, US government debt is increasing, US households savings are trending up and household debt is decreasing albeit it is still high, there is low unemployment but no wage growth and poverty is increasing. Some of the signs are a bit paradoxical such as the low wage growth which could be a partial reason why the poverty levels are increasing and consumer spending is decreasing.

So we have looked at some of the principle indicators that should provide some insight into the true health of the economy. You can take it how you see it but regardless, you have to admit that the picture is not crystal clear. Despite that, the financial media’s use of exaggerated claims such as, “Strong,” “Booming,” or “Firing on all cylinders,” gives the indication that we have entered a new era. President Trump seems to have changed his stance on the figures, touting and taking credit for the unemployment numbers that he criticized as candidate Trump. He also recently said, the US is “setting records on virtually every front” and is “probably the best our country has ever done.”

In the end, if the general public truly believe these claims, experience it in their neighbourhoods and families, they will have the confidence to go out and spend. Greater consumption patterns will improve the health of companies and they will hire. You would expect wage growth thereby lifting the standard of living across the nation. If the public does not believe the hyperbole, they will pull in their spending and try to reduce their personal debt levels. They will protect themselves.

In the end perception wins out. You be the judge.

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The Debt Jubilee – “There ain’t no such thing as a free lunch”

By | Economics, Finance

It should be no surprise to anybody who has been reasonably informed about what has gone on in the last 15 or so years that debt is becoming a burden. This has become an issue not only in the US but pretty much everywhere all over the world. The debt has come in many forms such as student loan debt, credit card debt, medical debts, personal loans, and on a national scale you have the national debt, underfunded pension liabilities, medicare etc. 

The big issue is how to manage it. A few are talking about it but only in the form of a warning, “someday soon we will have to deal with it.” They keep pushing it off. However the longer you push off a problem like the one we face, the more pressing the problem becomes and that tends to eliminate the bulk of your options to deal with it when it really comes due. 

There has been a potential solution that has been bantered about for the past few years. However, it has been presented as the only solution that will be left when it becomes too late to entertain any others. The solution is known as the “Debt Jubilee,” or debt forgiveness. It means what its name implies, that if someone owes you money you just forgive the debt. The debtor is no longer required to pay back the money he/she owes.

This idea has in fact been around for a long time. Historians have counted around thirty episodes of general debt cancellations from 2400 to 1400 BC, noting they were occasions of great festivity which often involved the physical destruction of the tablets on which liabilities were recorded. One of the most famous episodes of debt forgiveness comes from ancient Babylon (modern-day Iraq). In 1792 BC, the self-proclaimed King Hammurabi of Babylon forgave all citizens’ debts owed to the government, high-ranking officials, and dignitaries (read more from our post about Hammurabi here). The Code of Hammurabi, which currently sits in the Louvre in Paris, declared:

“If any one owe a debt for a loan, and a storm prostrates the grain, or the harvest fail, or the grain does not growth for lack of water, in that year he need not give his creditor any grain, he washes his debt-tablet in water and pays no rent for this year.” 

The main thing to remember is that at that time the main creditor in most cases was the King himself, and/or institutions closely aligned with the monarch. It was relatively easy for the King to abolish debts owed directly to himself or the royal institutions, or even to a substantial proportion of wealthy creditors.

Debt forgiveness was also practiced during the time of the Old Testament. In Jewish Mosaic Law, every seventh Sabbath year saw the wiping away of all debts, where creditors cancelled all the obligations of their fellow Israelites. Every 49th year (seven Sabbath years) was the ‘Year of the Jubilee’ when freedom from all debt and servitude was proclaimed throughout the land.

This practice of debt forgiveness was not purely altruistic on the part of the creditors and ruling class. History has shown that if debtors become too enslaved to their creditors and ruling class, too disenfranchised, it opens the door for opposers or competing rulers to recruit the debtors in revolts to overthrow the ruling class. In current times, protests such as those led by the Occupy Movement show that these issues are still prevalent today and are never too far from boiling over.

At the end of World War I, Europe emerged mired in debt and in a depression. By the mid-1930s, many countries began to abandon the Gold Standard in an attempt to reflate their economies without the burden of an exchange-rate system. As part of this process, most of Europe’s governments had a significant portion of their liabilities written-off for good.

As recent as World War II the practice of debt forgiveness has been exercised. Following the end of WWII, the London Debt Agreement of 1953 saw the abolition of all of Germany’s external debt. The total forgiveness amounted to around 280% of GDP from 1947-53. This last episode is important because it is central to why a debt jubilee may not be the panacea that many believe. 

Michael Hudson highlighted why jubilee, debt cancellations, cannot now be replicated exactly:

“……the main credit/debt transactions initially were undertaken directly between the (ultimate) creditor and (ultimate) debtor. The largest credit relationship was between the government and taxpayers. Nowadays a very large proportion of all financial transactions are intermediated via financial institutions. Any attempt to cancel some category of debt, say government debt or personal mortgages, would immediately drive those financial intermediaries holding such assets, e.g. banks, pension funds, investment trusts, into insolvency.”

There are many economic and ethical problems with the debt jubilee concept. It would essentially amount to the government stealing wealth from all lenders and giving it to all borrowers. The more nefarious or corrupt you were prior to the jubilee, the more you would make out like a bandit as a result of the jubilee. A debt jubilee would paral­yse the finan­cial sec­tor by destroy­ing bank assets. In an era of secu­ri­tized finance, the own­er­ship of debt is engrained in society in the form of asset based secu­ri­ties (ABS) that gen­er­ate income streams on which a mul­ti­tude of non-bank recip­i­ents depend. Debt forgiveness would eventually destroy both the assets and the income streams of own­ers of ABSs, most of whom are inno­cent bystanders. 

As we mentioned earlier, the example of Germany’s debt foregiveness after World War II is an important one. LSE Professor of Economic History Albrecht Ritschl conducted research into how Germany was able to pay off its debts after the two World Wars:

“In a telling comparison Ritschl showed that the debts racked up by the struggling Eurozone economies – Portugal, Italy, Ireland, Greece and Spain – were equal in size to Germany’s current gross domestic product. In other words, debt cancellation for the Eurozone would be equivalent to the debts that were cancelled by the Allies after World War II.”

When polled whether or not Greece should be the recipient of some form of debt cancellation from the eurozone, only 16% of polled Germans agreed. The irony may have been lost on some.

The world’s financial system is more interconnected than ever. Debt forgiveness would take on an unimaginable complexity. There are a large number of counter-party risks as shown by the Deutsche Bank example below:

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This would no longer be a one to one abolishment of debt as in the days of Hammurabi. Any debt forgiveness of one party would affect a number of other parties. As free market economist Milton Friedman once said, “There ain’t no such thing as a free lunch.” It may be time to devise another plan, and quickly. 

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Is a strong middle class the key to a strong economy?

By | Economics, Politics

In our previous article titled “Where did the US go off track?” The article was meant mainly to revisit Bernanke’s planned wealth effect from quantitative easing and indicate that it was an ill advised idea that put many into deeper trouble than before. The title was a general statement of wonder as opposed to identifying where the US did go off track.

This time we look at where the US went off track by identifying when the US was at its strongest and why. If we can understand where it really went off track then we can look for solutions or at least understand what kind of solutions are required.

Economies have ebbs and flows. In spite of what they teach you in economics 101 nothing is ever in equilibrium. There are just too many parts as well as internal and external influences although there are times when activity is stronger than others.  The US built one of the greatest economic powerhouses on earth after World War II, however it was already well on its way from the 1800s as it built out its infrastructure and put many to work. There was a time when the US consumed the majority of what it produced as a nation and then exported the remainder. Who was responsible for the consumption? It was the middle class. The middle class made up the majority of the population. They had jobs and respectable salaries. So what happened?

According to a research report by the Pew Research Center in 2012, “The Lost Decade of the Middle Class”they state:

“For the half century following World War II, American families enjoyed rising prosperity in every decade—a streak that ended in the decade from 2000 to 2010, when inflation-adjusted family income fell for the middle income as well as for all other income groups, according to U.S. Census Bureau data.”

The above graph shows that the 50s and 60s had the strongest middle class. In 1950 and 1951 the US had successive years of 8% GDP growth. The report also highlights how the net worth of middle income families—that is, the sum of assets minus debts— took a hit from 2001 to 2010 from the Federal Reserve’s Survey of Consumer Finances. Median net worth fell 28%, to $93,150, erasing two decades of gains. So we have a situation where consumer debt has increased over the years and incomes have fallen. There are a large number of reasons for this. The manufacturing base has shrunk as companies chose to produce goods in other countries in order to take advantage of cheap labour so they could give themselves pricing advantages. There is, what has become to be known as the “Walmartization” of America. Author John Atcheson writes, “If you want to know why the middle class disappeared and where they went, look no further than your local Walmart.  People walked in for the low prices, and walked out with a pile of cheap stuff, but in a figurative sense, they left their wages, jobs, and dignity on the cutting room floor of the House of Cheap.” Driving prices lower and lower is just a race to the bottom that erodes everyone’s quality of life.

This is just scratching the surface. There is also the invention of the 401k. We hold a total of $17.5 trillion in retirement funds – the single biggest source of money the big banks, Wall Street, and assorted other speculators use to play with.

The power of capitalism has been the freedom for entrepreneurs to create and provide value to others which has in turn provided jobs and increased wealth. However, we are now seeing that there are limits to that. The Economist recently revisited some of Karl Marx’s thinking regarding capitalism:

“Marx argued that capitalism is in essence a system of rent-seeking: rather than creating wealth from nothing, as they like to imagine, capitalists are in the business of expropriating the wealth of others. Marx was wrong about capitalism in the raw: great entrepreneurs do amass fortunes by dreaming up new products or new ways of organising production. But he had a point about capitalism in its bureaucratic form. A depressing number of today’s bosses are corporate bureaucrats rather than wealth-creators, who use convenient formulae to make sure their salaries go ever upwards. They work hand in glove with a growing crowd of other rent-seekers, such as management consultants (who dream up new excuses for rent-seeking), professional board members (who get where they are by not rocking the boat) and retired politicians (who spend their twilight years sponging off firms they once regulated).”

What country currently resembles the US of the 1950s with roughly 8% GDP growth? You probably guessed right, China. Aside from the fact that China has been handed every manufacturing job in the world from others, the result has been a growing middle class which will soon become larger than the population of the US. According to a study by consulting firm McKinsey & Company, 76 percent of China’s urban population will be considered middle class by 2022. That’s defined as urban households that earn US$9,000 – US$34,000 a year. (That might not sound like a lot, but adjusted for prices, it delivers a roughly comparable “middle class” existence to other countries.) In 2000, just 4 percent of the urban population was considered middle class.

So if building the middle class back up is to make the US stronger once again, what are some solutions? Providing better paying jobs for Americans by bringing back the manufacturing base to the US? Prices may increase but if your job is providing you a salary that enables you to afford it you may not mind. That would mean forcing US companies back to the US. That would mean providing them incentives in the form of tax breaks. We have already seen that those tax breaks are turning into stock buybacks. This is just exacerbating the situation, meaning, the government will forgo potential revenue that could have come in the form of those taxes. The tax breaks are not being used for capital investment, which would flow into the economy. The result is a larger national debt burden. How about incentivizing foreign companies to move their manufacturing to the US? Forget the financial engineering of the economy, the focus has to be on developing enterprises, but only to a point.

Companies like Amazon and Walmart have destroyed many small and medium sized companies by driving prices lower at the expense of putting many out of work. We have seen no evidence that Amazon and Walmart have created more jobs than they have destroyed. Google and Facebook have essentially taken over the advertising industry. So would it make sense to cap how large a company could grow? There are laws against monopolies and oligopolies however their political capital has become so strong that they can easily avoid these laws. However, it may make sense to break these companies up.

We can follow Marx and reduce the number of corporate bureaucrats that are sponging off the system, many of whom are found in banks. Banks are now much larger than the too big to fail era. Now they are way too big to fail. Breaking them up is currently being discussed. In fact, investment banks should be completely separated from commercial banks, or better yet community banks. Banks that serve only their communities. In this way, if investment banks makes bad decisions they are penalised by their investors, as opposed to sucking money out of their commercial counterparts in turn penalising the depositors (beware the coming bail-ins during the next financial crisis)! Regardless of the solutions implemented, it has to be accepted that they will not please everyone.

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Where did the United States go offtrack?

By | Economics

While the war between Trump supporters, anti-Trump protestors and the media rages on over everything from Trump policies to Trump tweets, there is an evident truth lurking beneath the surface of all the bravado. The truth is that the country is no longer the land of milk and honey nor the example for everyone else to follow. In spite of what financial media would have you believe regarding full employment and a booming economy, it is not the reality for many. As my uncle used to say, “When your neighbour is out of work it is a recession, when you are out of work it is a depression.”

According to the recent released United Nations Human Rights Council document titled, “Report of the Special Rapporteur on extreme poverty and human rights on his mission to the United States of America,” the United States is a land of “stark contrast.” The report relies principally upon official government statistics, especially from the United States Census Bureau.

According to the report’s findings, it seems to be more clear that the wealth effect promised by Bernanke’s Fed did materialize, only the wealth trickled up and not down. In The Washington Post , Ben Bernanke wrote on November 4, 2010, “the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability.” He went on to say, “Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending”.

So how did that work out? The report explains:

“…its immense wealth and expertise stand in shocking contrast with the conditions in which vast numbers of its citizens live. About 40 million live in poverty, 18.5 million in extreme poverty, and 5.3 million live in Third World conditions of absolute poverty. It has the highest youth poverty rate in the Organization for Economic Cooperation and Development (OECD), and the highest infant mortality rates among comparable OECD States. Its citizens live shorter and sicker lives compared to those living in all other rich democracies, eradicable tropical diseases are increasingly prevalent, and it has the world’s highest incarceration rate, one of the lowest levels of voter registrations in among OECD countries and the highest obesity levels in the developed world.”

It has become painfully clear for many that Bernanke, student of the Great Depression, made some serious miscalculations about how money would flow and to whom. According to the report, the United States now has the highest rate of income inequality among Western countries.

So there was a slight miscalculation regarding the Fed’s monetary policies. When those don’t work out as planned, you turn to fiscal policies. How is that working out?

The Hutch Report

“The $1.5 trillion in tax cuts in December 2017 overwhelmingly benefited the wealthy and worsened inequality.”

Curiously, since the tax bill was signed, a number of companies have been doing a lot of buybacks. Share buybacks in 2018 have averaged $4.8 billion per day, double the pace from the same period last year, according to an analysis the market data firm TrimTabs provided to CNBC.

It has only been 6 months since the tax cuts have been enacted and it takes time for these moves to make their way through the system, however, according to findings in the report you shouldn’t expect any surprising results.

“The share of the top 1 per cent of the population in the United States has grown steadily in recent years. In 2016 they owned 38.6 per cent of total wealth. In relation to both wealth and income the share of the bottom 90 per cent has fallen in most of the past 25 years. The tax reform will worsen this situation and ensure that the United States remains the most unequal society in the developed world. “

The report addresses the singular optimistic views of new technologies in regard to their benefits yet fail to highlight specific impact of these new technologies on the lives of the poor in American society today. Robotics may help McDonalds create efficiencies by doing away with order takers but will most likely only exacerbate the existing wealth inequality issues.

The current heated debate on Trump’s immigration policies have put the plight of the innocent immigrant children in full view. Nobody wants to see children taken from their families. At the same time that this debate is raging with the constant flow of images from CNN to hammer home the point that it is wrong, they fail to recognize the current situation that many American children experience daily.

“Poor children are also significantly affected by the country’s crises regarding affordable and adequate housing. On a given night in 2017, about 21 per cent (or 114,829) of homeless individuals were children. But this official figure may be a severe underestimate, since homeless children temporarily staying with friends, family or in motels are excluded from the point-in-time count. According to the Department of Education, the number of homeless students identified as experiencing homelessness at some point during the 2015/16 school year was 1,304,803.”

One can argue that there is always the Supplemental Nutrition Assistance Program (food stamps), which was put in place to help this portion of the population. According to findings, the program kept 3.8 million children out of poverty in 2015, and in 2016, the earned income tax credit and the child tax credit lifted a further 4.7 million children out of poverty. However, Trump may just blow up the farm bill over demanding food stamp work requirements. That demand, could mean tens of billions of dollars in cuts to the anti-poverty program.

The report pulls no punches and highlights a number of concerning issues such as, Treatment of the poor in the criminal justice system, Criminalization of the homeless, Environmental pollution, and Confused and counterproductive drug policies.

Not everyone agrees with the way in which the report is written as Fox News highlights in an opinion piece, “UN poverty report blasting Trump, US for ‘hatred for the poor’ uses data from last year of Obama’s presidency.” But once again, regardless of the facts, they spin it into a political positioning attack.

Although the report does list a number of recommendations, we find it hard to believe that the current government parties will put doing the “right and effective thing” in order to get the country back on track, in front of doing what is most effective at getting themselves re-elected.

The Hutch Report

Market Forecasting is Dead

By | Economics, Finance

The ability to forecast the markets is dead. It can also be argued that it never existed.

Regardless of that oversight, we are entertained by a constant stream of “experts” on financial media who profess to understand why the market has acted on any given day, or how it will act tomorrow. Everyone of them is trying but very few get it right. When they do get it right you can attribute it to pure chance, as their track records for being consistent are far and few between.

Many investors, individual as well as institutional, rely on market experts and forecasters when making investment decisions, regardless of the fact that they keep coming up short. For example, on 3 January 2015 Thomas Lee predicted that the S&P 500 index would be at 2325 one year from his prediction. The S&P 500 ranged between 1867 and 2122 during this period, and closed at 2012 on 4 January 2016, well short of the goal. There have been several previous analyses of forecaster accuracy, both in academic literature and also in the financial press in the past. Although many will correlate with the S&P 500 during years of stability (where you could essentially just apply a variety of statistical methods to extrapolate into the future), they have been seen to be surprisingly unreliable during major shifts in the market. For example, an analysis by Nir Kaissar found that the strategists overestimated the S&P 500’s year-end price by 26.2 percent on average during the three recession years 2000 through 2002, yet they underestimated the index’s level by 10.6 percent for the initial recovery year 2003.

There are a variety of reasons why forecasting the markets is a futile exercise. As Nassim Taleb puts it – “The tragedy is that much of what you think is random is in your control and, what’s worse, the opposite.” Regular savings are in your control, your expectations and behaviour is also in your control, however, stock market moves in an uncertain world are not.


Fundamentally, businesses usually go public to raise capital in hopes of expanding. The ownership of the business is then spread among a large group of shareholders. If the company’s earnings are solid and consistent, the share price is valued higher and the shareholders get rewarded for putting their money at risk. These companies issue quarterly and yearly earnings reports in order to provide current and any potential future shareholders a snapshot of the health of the company at that moment. To do so they usually apply what we call, “Generally Accepted Accounting Principles.”

But as the MIT Sloan Management Review recently pointed out,

“Lurking within the financial statements and communications of public companies is a troubling trend. Alternative metrics, once used sparingly, have become increasingly ubiquitous and more detached from reality.”

They went on to provide the following example:

“In 2011, Groupon Inc. announced plans for a highly anticipated initial public offering. But enthusiasm for the offering waned when the U.S. Securities and Exchange Commission (SEC) issued a comment letter questioning Groupon’s use of a profit metric it called “adjusted consolidated segment operating income.” To our knowledge, no company had ever used that metric before; it was intended to measure operating profit without including marketing expenses, stock-based compensation, and acquisition-related costs. Management argued that a $420 million loss from operations reported on its 2010 income statement should really be considered a $60 million gain.”

This is not an isolated example, and the use of these so called, “Accounting tricks” have only become more sophisticated. What was once analysis of a business’s operations and their ability to satisfy customers and grow has become an exercise of forensic accounting analysis in order to spot the manipulators! Try forecasting the next clever income statement adjustment!

The Federal Reserve

What were once pretty much free markets have become markets that have become pretty much dependent on the next Central Bank intervention. QE1 took place in November 2008 when the Fed spent $600 billion on purchase of Mortgage-backed Securities (MBS) in order to “save” the financial system from ruin (which could be argued that they facilitated in the first place). But they didn’t stop there. They continued with QE2, Operation Twist, Operation Twist Extended and QE3. It didn’t stop with the Fed, as they do work closely with their central bank colleagues, such as the ECB and BOJ.

Total Assets of Major Central Banks

Was there an impact on the financial markets? Of course there was. They drove interest rates pretty much to zero for an extended period. As Quicken Loans pointed out, there will be a time when the Fed has to get out of their positions and when that happens:

“A new buyer, or more likely several of them, would have to pick up the slack and buy lots of MBS in order to keep mortgage rates where they are right now. No one has a crystal ball as to when the Fed will start to get out of the MBS market, either.”

So without a crystal ball or being privy to what the Federal Reserve has planned regarding future manipulations of the market, trying to forecast them is a futile exercise that serves no purpose.

High-Frequency Trading, Spoofing, and other Shenanigans

In addition to accounting trickery and central bank intervention, here are a few more choice headlines and examples as to why forecasting the markets is dead.

“Six banks fined $5.6bn over rigging of foreign exchange markets”

“HSBC faces fresh suit alleging forex manipulation”

“BNP Paribas pleads guilty to forex manipulation”

“Wells Fargo Accused Of Manipulating Business Banking Data”

Since 2007 we have seen a new player in town, high frequency traders. High-frequency trading is an automated trading platform used by large investment banks, hedge funds and institutional investors that utilizes powerful computers to transact a large number of orders at extremely high speeds. This has completely changed the dynamics of the markets. As JP Morgan pointed out in their own report of June 13, 2017:

“While fundamental narratives explaining the price action abound, the majority of equity investors today don’t buy or sell stocks based on stock specific fundamentals,” Marko Kolanovic, global head of quantitative and derivatives research at JPMorgan, said in a Tuesday note to clients.

Kolanovic estimates “fundamental discretionary traders” account for only about 10 percent of trading volume in stocks. Passive and quantitative investing accounts for about 60 percent, more than double the share a decade ago, he said.

Which introduced another brilliant market manipulation called “spoofing,” and another choice headline to present:

“Gold, Silver Manipulation: CFTC Fines Deutsche, USB, HSBC For Spoofing Markets”

The CFTC announced earlier this year that Deutsche Bank, UBS and HSBC faced fines totaling $46.6 million. Deutsche Bank was the hardest hit as it was fined $30 million. UBS was ordered to pay $15 million and HSBC was fined $1.6 million.

How about naked short selling? Naked short selling, or naked shorting, is the practice of short-selling a tradable asset of any kind without first borrowing the security or ensuring that the security can be borrowed, as is conventionally done in a short sale.

Paul Craig Roberts described this process as it is used in the gold markets:

“This manipulation by the Fed involves the short-selling of uncovered Comex gold futures. “Uncovered” means that these are contracts that are sold without any underlying physical gold to deliver if the buyer on the other side decides to ask for delivery. This is also known as “naked short selling.” The execution of the manipulative trading is conducted through one of the major gold futures trading banks, such as JPMorgan Chase, HSBC, and Bank of Nova Scotia. These banks do the actual selling on behalf of the Fed.”

To see proof of this, one just has to check the latest Comex Reports to see that the current ratio of paper gold to physical gold is 176:1.


The next time you are watching your favorite financial media program providing explanations as to what the market is doing now and what the market will do,  remember the previous points. Remember to ask yourself two questions, “Does this person really have the ability to forecast the markets,” and “should I have confidence in any of their conclusions?” Because, in reality, market forecasting is dead!