The Limits of OPEC

There’s rampant speculation and zero consensus about the direction OPEC will take in their upcoming Vienna meeting, November 27.

Last Friday, for example. Bloomberg reported,

The 20 analysts surveyed this week by Bloomberg are perfectly divided, with half forecasting the Organization of Petroleum Exporting Countries will cut supply on Nov. 27 in Vienna to stem a plunge in prices while the other half expect no change. In the seven years since the surveys began, it’s the first time participants were evenly split. The only episode that created a similar debate was the OPEC meeting in late 2007, when crude was soaring to a record.

Many discussions pose the strategic choice as one between –

(a) cutting production to maintain prices, but at the cost of losing market share to the ascendant US producers, and

(b) sustaining current production levels, thus impacting higher-cost US producers (if the low prices last long enough), but risking even lower oil prices – through speculation and producers breaking ranks and trying to grab what they can.

Lybia, Ecuador, and Venezuela are pushing for cuts in production. Saudi Arabia is not tipping its hand, but is seen by many as on the fence about reducing production.

I’m kind of a contrarian here. I think the sound and fury about this Vienna meeting on Thanksgiving may signify very little in terms of oil prices – unless global (and especially Chinese) economic growth picks up. As the dominant OPEC producer, Saudi Arabia may have market power, but, otherwise, there is little evidence OPEC functions as a cartel. It’s hard to see, also, that the Saudi’s would unilaterally reduce their output only to see higher oil prices support US frackers continuing to increase their production levels at current rates.

OPEC Members, Production, and Oil Prices

The Organization of Petroleum Exporting Countries (OPEC) has twelve members, whose production over recent years is documented in the following table.

OPECprod

According to the OPEC Annual Report, global oil supply in 2013 ran about 90.2 mb/d, while, as the above table indicates, OPEC production was 30.2 mb/d. So OPEC provided 33.4 percent of global oil supplies in 2013 with Saudi Arabia being the largest producer – overwhelmingly.

Oil prices, of course, have spiraled down toward $75 a barrel since last summer.

WTIchart

Is OPEC an Effective Cartel?

There is a growing literature questioning whether OPEC is an effective cartel.

This includes the recent OPEC: Market failure or power failure? which argues OPEC is not a working cartel and that Saudi Arabia’s ideal long term policy involves moderate prices guaranteed to assure continuing markets for their vast reserves.

Other recent studies include Does OPEC still exist as a cartel? An empirical investigation which deploys time series tests for cointegration and Granger causality, finding that OPEC is generally a price taker, although cartel-like features may adhere to a subgroup of its members.

The research I especially like, however, is by Jeff Colgan, a political scientist – The Emperor Has No Clothes: The Limits of OPEC in the Global Oil Market.

Colgan poses four tests of whether OPEC functions as a cartel -.

new members of the cartel have a decreasing or decelerating production rate (test #1); members should generally produce quantities at or below their assigned quota (test #2); changes in quotas should lead to changes in production, creating a correlation (test #3); and members of the cartel should generally produce lower quantities (i.e., deplete their oil at a lower rate) on average than non-members of the cartel (test #4)

Each of these tests fail, putting, as he writes, the burden of proof on those who would claim that OPEC is a cartel.

Here’s Colgan’s statistical analysis of cheating on the quotas.

OPECquota

On average, he calculates that the nine principal members of OPEC produced 10 percent more oil than their quotas allowed – which is equivalent to 1.8 million barrels per day, on average, which is more than the total daily output of Libya in 2009.

Finally, there is the extremely wonkish evidence from academic studies of oil and gas markets more generally.

There are, for example, several long term studies of cointegration of oil and gas markets. These studies rely on tests for unit roots which, as I have observed, have low statistical power. Nevertheless, the popularity of this hypothesis seems to be consistent with very little specific influence of OPEC on oil production and prices in recent decades. The 1970’s may well be an exception, it should be noted.

We will see in coming weeks. Or maybe not, since it still will be necessary to sort out influences such as quickening of the pace of economic growth in China with recent moves by the Chinese central bank to reduce interest rates and keep the bubble going.

If I were betting on this, however, I would opt for a continuation of oil prices below $100 a barrel, and probably below $90 a barrel for some time to come. Possibly even staying around $70 a barrel.

DSCN0508

Some Thoughts on Japan

I saw the news that Japan has fallen into recession again. This “hit the wires” just after the Bank of Japan surprised everyone and announced a major new quantitative easing (QE) program.

Japan is a country of 127 million persons (2013) with one of the largest economies in the world, as this chart shows.

countryGDP

Basically, though, the Japanese economy has been a start/stop mode since the mid-1990’s. According these GDP estimates, China surpassed Japan 2008-2009, and now in nominal terms has a production level twice that of Japan.

The data are from the World Economic Outlook database (IMF) and are not inflation-adjusted, but are converted into US dollar equivalents.

Where’s the Beef?

Well, a person In Kansas might say, “So what?” Why is Japan important?

I think there are several reasons.

First, a recession in Japan, because of its continuing economic size, has the capability of affecting global markets.

According to the CIA Factbook .. on a purchasing power parity (PPP) basis that adjusts for price differences, Japan in 2013 stood as the fourth-largest economy in the world after second-place China, which surpassed Japan in 2001, and third-place India, which edged out Japan in 2012.

Simultaneous recessions in Japan and Europe almost surely would trigger a global economic slowdown, unless the American consumer just went crazy.

Test Case for Macroeconomic Policy

Another reason Japan is important is as a sort of test case for macroeconomic policy, as well as for the impacts of an aging population.

This chart shows the intermittent economic growth in Japan since the 1990’s along with the deflationary trend.

JapanrGDPCPI

These figures are developed from official Japanese statistics.

Notice that you could start at around 1999 and draw a trendline for the Japanese CPI to about 2013, where a brief period 2008-2009 would appear as a blip away from this trendline.

Deflation has been a twenty year phenomena in Japan, and the current government, under Abe, has sought to break its hold with a triple-threat of fiscal policy, monetary policy, and structural reform.

The result is a continuation of the climb in the liabilities to GDP ratio of the Bank of Japan (BOJ), as shown in this chart extracted from Bloomberg sources.

Japmonebasedelta

So “steady as she goes,” the monetary base of Japan will reach about 50 percent of Japanese GDP within a year or two. This compares with a figure of just less than 20 percent for the United States.

The swing into negative growth in 2014 was triggered by a substantial increase in the VAT or value-added tax in Japan, and there is vigorous debate about future increases – viz Krugman Japan on the Brink.

Structural Reform

I wonder whether it might be better to question the religion of economic growth, than to attempt “structural reform” aka reductions in the real wage.

In any case, it easy to see that the recent surge in Japanese inflation, combined with additional consumption taxes and, indeed, negative economic growth mean that Japanese real wages are being reduced in real time here. Indeed Edward Hugh documents this with reference to official Japanese statistics.

But this is a slippery slope.

On the one hand, reductions in the real wage could make domestically produced Japanese goods more competitive in international markets.

On the other hand, domestic purchasing power could suffer, or, at the least, there could be a move to increasing concentrations of wealth. We’ve certainly seen that in the United States, where the real wage of workers has declined off and on, since 1971, compensated for, to an extent, by the entry of women into the workforce and two-wage households.

The limits of human intellect can be found right here. The enormous production growth in China has been accompanied by choking air pollution which, I can assure you from personal experience, is simply amazingly bad sometimes. Health-threatening. Yet the Chinese naturally want to expand their productive apparatus to the extent they can, for purposes of providing for their vast population and in order to secure China’s place in the global economy.

But life in Japan – during these decades when economic growth has been very intermittent and prices have dropped – life has been fairly good. That’s one reason why many Japanese are now starting to enjoy their older years in a degree of relative comfort unimaginable one or two generations ago.

Maybe some Japanese visionary can come up with a sequel to Herman Daly’s steady state economy idea – a kind of reverse mortgage for an entire economy perhaps.

Quantitative Easing (QE) and the S&P 500

Reading Jeff Miller’s Weighing the Week Ahead: Time to Buy Commodities 11/16/14 on Dash of Insight the following chart (copied from Business insider) caught my attention.

stocksandQE

In the Business Insider discussion – There’s A Major Problem With The Popular Chart That Connects The Fed To The Stock Market – Myles Udland quotes an economist at Bank of America Merrill Lynch who says,

“Implicitly, this chart assumes that the markets are not forward looking and it is the implementation of Q that drives the stock market: when the Fed buys, the market booms and when it stops, the market swoons..”

“As our readers know [Ethan Harris of Bank of America Merrill Lynch writes] we think this relationship is a classic case of spurious correlation: anything that trended higher over the last 5 years has a 90%-plus correlation with the Fed’s balance sheet.”

This makes a good point inasmuch as two increasing time series can be correlated, but lack any essential relationship to each other – a condition known as “spurious correlation.”

But there’s more to it than that.

I am surprised that these commentators, all of whom are sophisticated with numbers, don’t explore one step further further and look at first differences of these time series. Taking first differences turns Fed liabilities and the S&P 500 into stationary series, and eliminates the possibility of spurious correlation in the above sense.

I’ve done some calculations.

Before reporting my results, let me underline that we have to be talking about something unusual in time, as this chart indicates.

SPMB

Clearly, if there is any determining link between these monthly data for the monetary base (downloaded from FRED) and monthly averages for the S&P 500, it has be to after sometime in 2008.

In the chart above and in my  computations, I use St. Louis monetary base data as a proxy for the Fed liabilities series in the Business Insider discussion,

So then considering the period from January 2008 to the present, are there any grounds for claiming a relationship?

Maybe.

I develop a “bathtub” model regression, with 16 lagged values of the first differences of the monetary base numbers to predict the change in the month-to-month change in the S&P 500. I use a sample from January 2008 to December 2011 to estimate the first regression. Then, I forecast the S&P 500 on a one-month-ahead basis, comparing the errors in these projections with a “no-change” forecast. Of course, a no change forecast is essentially a simple random walk forecast.

Here are the average mean absolute percent errors (MAPE’s) from the first of 2012 to the present. These are calculated in each case over periods spanning January 2012’s MAPE to the month of the indicated average, so the final numbers on the far right of these lines are the averages for the whole period.

cumMAPE

Lagged changes in the monetary base do seem to have some predictive power in this time frame.

But their absence in the earlier period, when the S&P 500 fell and rose to its pre-recession peak has got to be explained. Maybe the recovery has been so weak that the Fed QE programs have played a role this time in sustaining stock market advances. Or the onset of essentially zero interest rates gave the monetary base special power. Pure speculation.

Interesting, because it involves the stock market, of course, but also because it highlights a fundamental issue in statistical modeling for forecasting. Watch out for correlations in increasing time series. Always check first differences or other means of reducing the series to stationarity before trying regressions – unless, of course, you want to undertake an analysis of cointegration.

Video Friday – Benefits and Risks of Alcoholic Drinks

Like almost everyone who enjoys beer, wine, and mixed drinks, I have been interested in the research showing links between moderate alcohol consumption and cardiovascular health. In discussions with others, I’ve often heard, “now that’s the kind of scientific research we need more of” and so forth.

But obviously, booze is a two-edge sword.

So this research by Dr. James O’Keefe, a cardiologist from Mid America Heart Institute, with his co-authors Dr. Salman K. Bhatti, Dr. Ata Bajwa, James J. DiNicolantonio, Doctor of Pharmacy, and Dr. Carl J. Lavie caught my eye, because its comprehensive review of the literature on both benefits and risks.

It was published in the Mayo Clinic Proceedings, and here Dr. O’Keefe summarizing the findings.


The Abstract for this research paper, Alcohol and Cardiovascular Health: The Dose Makes the Poison…or the Remedy, lays it out pretty clearly.

Habitual light to moderate alcohol intake (up to 1 drink per day for women and 1 or 2 drinks per day for men) is associated with decreased risks for total mortality, coronary artery disease, diabetes mellitus, congestive heart failure, and stroke. However, higher levels of alcohol consumption are associated with increased cardiovascular risk. Indeed, behind only smoking and obesity, excessive alcohol consumption is the third leading cause of premature death in the United States. Heavy alcohol use (1) is one of the most common causes of reversible hypertension, (2) accounts for about one-third of all cases of nonischemic dilated cardiomyopathy, (3) is a frequent cause of atrial fibrillation, and (4) markedly increases risks of stroke—both ischemic and hemorrhagic. The risk-to-benefit ratio of drinking appears higher in younger individuals, who also have higher rates of excessive or binge drinking and more frequently have adverse consequences of acute intoxication (for example, accidents, violence, and social strife). In fact, among males aged 15 to 59 years, alcohol abuse is the leading risk factor for premature death. Of the various drinking patterns, daily low- to moderate-dose alcohol intake, ideally red wine before or during the evening meal, is associated with the strongest reduction in adverse cardiovascular outcomes. Health care professionals should not recommend alcohol to nondrinkers because of the paucity of randomized outcome data and the potential for problem drinking even among individuals at apparently low risk. The findings in this review were based on a literature search of PubMed for the 15-year period 1997 through 2012 using the search terms alcohol, ethanol, cardiovascular disease, coronary artery disease, heart failure, hypertension, stroke, and mortality. Studies were considered if they were deemed to be of high quality, objective, and methodologically sound.

Did someone say there is no such thing as a free lunch? Note, “among males aged 15 to 59 years, alcohol abuse is the leading risk factor for premature death.”

There is some moral here, possibly related to the size of the US booze industry, an estimated $331 billions in 2011 about equally distributed between beer and for the other part wine and hard liquor.

Also I wonder with the growing legal acceptance of marijuana at the state level in the US, whether negative health impacts would be mitigated by substitution of weed for drinking. Of course, combination of both is a possibility, leading to drug-crazed drunks?

Maybe the more important issue is to bring people’s unquestionable desire for mind-altering substances into focus, to understand this urge, and be able to develop cultural contexts in which moderate usage can take place.

Investment and Other Bank Macro Forecasts and Outlooks – 2

Today, I take a brief look at economic forecasts available from Morgan Stanley, Wells Fargo, and the French concern Credit Agricole. As readers will note, Morgan Stanley has a lively discussion of the implications of the US midterms, while Wells Fargo has a very comprehensive and easy-to-access series of economic projections, ranging from weekly, to monthly and annual. Credit Agricole (apologies for omitting the accent mark) is the first European bank profiled in these brief looks, and has quarterly updates of fairly comprehensive economic projections across a range of variables.

And I might mention that these publications, which date back into September in many cases, are interesting to review both because of their projections and because of what they miss – notably the drop in oil prices and aggressive new round of quantitative easing by the Bank of Japan.

The fact these developments are missed in these September and even later releases qualifies them as genuine surprises. Thus, their impacts are not discounted in past market developments, and, going forward, oil prices and Japan QE could exert significant, discrete effects on markets.

Morgan Stanley

According to the Federal Reserve’s National Information Center, Morgan Stanley is the nation’s 6th largest bank.

JPMorgan

The Global Investment Committee (GOC) Weekly for November 10 is notable for some straight talk on the Implications of the US midterms, which Morgan Stanley see as slightly pro-growth, positive for equities, with constructive compromises, characteristic of lame duck presidencies. I quote fairly extensively, because the frankness of the insights and suggestions is refreshing.

The maxim that gridlock in Washington is good for markets has certainly held true during the “do nothing” Congress of the past two years. Now, with the Republicans winning control of the Senate and adding 15 seats to their House majority, the outlook appears to be for more of the same. Happily for investors, an analysis going back to 1900 shows that equity markets have averaged annualized 15% returns when the Congress is controlled by Republicans and the White House by a Democrat.

Although many pundits have suggested that the GOP sweep creates a mandate, the Global Investment Committee (GIC) sees the results as a mandate for change in the functioning and compromise in Washington rather than the embrace of a specific agenda. On that score, unlike the deeply partisan divide between the House and the Senate of the last four years that prevented any compromise bills from getting off the Hill, legislation may actually get to the president’s desk. While President Obama will be free to veto, he is now playing for his legacy and may be apt to compromise on some issues.

The Republicans’ challenge is to demonstrate leadership and competence in governing, a task that will require corralling the Tea Party caucus and, as Morgan Stanley & Co. Chief US Economist Vincent Reinhart wrote last week, “sequencing priorities” in a constructive way. Lacking a coherent issue-driven platform, most Republicans simply ran against Obama. Party infighting or an immediate battle about the debt ceiling and budget authorizations would likely be disastrous for the GOP—and the markets. From the GIC’s perspective, a better result would be for Congress to focus on job-creating initiatives and not on eviscerating the Affordable Care Act (ACA).

Agreement should be easiest around initiatives involving the energy sector, where this year’s 25% decline in oil prices has been front and center. American energy independence is no longer a dream but a real prospect with profound geopolitical as well as economic consequences (see Chart of the Week, page 3). Heretofore, the Keystone XL pipeline, a six-year-old proposal to connect Canadian oil with US Gulf Coast refineries, has been stalled amid wrangling with environmentalists. We believe the pipeline is now likely to win approval, creating a large national infrastructure project. Similarly, the growth of US energy supply is likely to reignite a debate on oil exports, which have been banned since the Arab oil embargoes of the 1970s. With US dollar strength likely to crimp other exports, expanding energy exports is a way to maintain economic growth. There is likely to be similar debate about exports of liquefied natural gas as the US is the world’s largest and lowest-cost producer. We believe that energy exports would be a major beneficiary focus if the new Congress approves the Trans-Pacific Partnership, a free trade agreement that would give the president authority to negotiate deals with 11 Asian nations.

Beyond energy, we expect repeal of the medical-device tax; expansion of defense spending, which has been curtailed under sequestration; and a debate on corporate tax reform, especially given the noise around tax-driven international mergers. Revisions to the ACA, to the extent they are pursued, will likely focus on measures that impact the number of insured and thus, hospitals and managed-care companies. The employer mandate, which requires employers with more than 100 workers to make available health insurance for any employee working more than 30 hours per week, is most likely to be revised, in our view.

As a final note, a review of state and local ballot initiatives suggest that voters are far from embracing an ideological position on fiscal austerity. Minimum-wage increases were passed in each state where they were on the ballot as did several large new-money infrastructure projects in New York and California—a development that MS & Co. Municipals Strategist, Michael Zezas, notes will likely increase bond supplies in 2015.

It looks like the august Global Economic Forum is being being published more infrequently than in the past, the last edition being March 5 of this year.

Wells Fargo

Wells Fargo, accounting to Wikipedia is –

an American multinational banking and financial services holding company which is headquartered in San Francisco, California, with “hubquarters” throughout the country… It is the fourth largest bank in the U.S. by assets and the largest bank by market capitalization…Wells Fargo is the second largest bank in deposits, home mortgage servicing, and debit cards. In 2011, Wells Fargo was the 23rd largest company in the United States.

The Wells Fargo website has a suite of forecasting reports, ranging from weekly, to monthly, to the big annual report, all downloadable in PDF format.

In October, the bank also released this video interview about their economic outlook.


In case you did not get time to watch that, one of the key graphics is the PCE deflator, which has been trending down recently, raising the spectre of deflation in the minds of some.

PCEdeflator

Credit Agricole

Credit Agricole is an international full services banking company, headquartered in France, with historical ties to French farming,

Their website offers at least two quarterly macroeconomic forecasting publications.

The publication Economic and Financial Forecasts presents a series of tabular forecasts for interest rates, exchange rates and commodity prices, together with the Crédit Agricole Group’s central economic projections. This is a kind of “just the numbers ma’am report.”

Macro Prospects is more discursive and with short highlights on key countries, such as, in the September issue, Brazil and China.

I signed up for emails from Credit Agricole, announcing updates of these documents.

investmentbanker

Investment and Other Bank Macro Forecasts and Outlooks – 1

In yesterday’s post, I detailed the IMF World Economic Outlook revision for October 2014, recent OECD macroeconomic projections,  and latest from the Survey of Professional Forecasters.

All these are publically available, quite comprehensive forecasts, sort of standards in the field.

But there also are a range of private forecasts, and I want to focus on investment and other bank forecasts for the next few posts – touching on Goldman Sachs and JP Morgan today.

Goldman Sachs

Goldman Sachs – video presentations on global economic outlook with additional videos for the US, Europe, and major global regions. December 2013

Goldman Sachs, Economic Outlook for the United States, June 2014, Jan Hatzius

Goldman Sachs Asset Management, FISG Quarterly Outlook Q4 2014, (click on the right of the page for Full Document). This is the most up-to-date forecast/commentary I am able to find, and has a couple of relevant points.

One concerns the policy divergence at the central bank level. This is even more true now than when the report was released (probably in October), since the Bank of Japan is plunging into new, aggressive quantitative easing (QE), while the US Fed has ended its QE program, for the time being at least.

The other point concerns the European economy.

Among our economic forecasts, our negative outlook on the Eurozone represents the biggest departure from consensus. We believe policymakers will struggle to correct the trend of poor growth and disinflation. Optimism about the peripheries has faded, and the Eurozone’s powerhouse economy, Germany, has slowed amid weak global demand. Once again the Eurozone’s political divisions and fiscal constraints leave the ECB as the only authority able to respond unilaterally to the threat of a sharper downturn, though hopes of fiscal action are mounting.

Some signs of a sustainable Eurozone recovery have not held up to closer inspection. The peripheries have made substantial progress on austerity and structural reforms, but efforts appear to have stalled, and Spain has probably reaped the most it can from its adjustment for now. Italy’s policy paralysis and relapse into recession is disappointing given this year’s changing of the political guard, which saw Silvio Berlusconi’s exit and Prime Minister Matteo Renzi’s election on a heavily reformist platform. Renzi has shifted gears from political reform to labor reform, which could get under way in early 2015. But Italy’s high debt stock makes it particularly vulnerable to a market backlash, and we are watching for signs of investor pullback that could drive sovereign yields higher.

JP Morgan

JP Morgan has a 2014 Economic Outlook in a special issue of their Thought magazine. This is definitely dated, but there is a weekly Economic Update in a kind of scorecard format (up/down/nochange) from their Asset Management Group.

I’ve got to say, however, that one of the most exciting publications along these lines is their quarterly Guide to the Markets from JP Morgan Asset Management. Here are highlights from an interactive version of the 4Q Guide.

First, the scope of coverage is impressive, although, note this is more of an update of conditions, than a forecast. The reader supplies the forecasts, however, from these engaging slides.

contentsJPM

But this slide does not need to produce a forecast to make its point – which is maybe we are not in a stock market bubble but at the start of a long upward climb in the market. Optimism forever!

StockMarketSince 1900

There are plenty of slides that have moral to the story, such as this one on education and employment.

educationemp

Then, this graphic on China is extremely revealing, and suggests a forward perspective.

chinastuff

I’m finding this excursion into bank forecasts productive and plan coming posts along these lines. I’d rather use the blog as a scratch-pad to share insights as I go along, than produce one humungous summary. So stay tuned.

Top photo courtesy of the University of Richmond

Global and US Economic Outlook – November 2014

There are a number of free, publically available macroeconomic forecast resources which have standing and a long track record.

Also, investment and other banks make partial releases of their macro projections.

IMF World Economic Outlook

The International Monetary Fund (IMF) revises its World Economic Outlook (WEO) toward the end of each year, this year in October with Legacies, Clouds, Uncertainties.

One advantage is comprehensive coverage. So there are WEO projections over 1, 2 and 3 year horizons for more than 100 countries, even obscure island principalities, and for dozens of variables, including GDP variously measured, inflation, imports and exports, unemployment rate, and population.

Here are highlights of the October revision (click to enlarge).

WEO14

Largely due to weaker-than-expected global activity in the first half of 2014, the growth forecast for the world economy has been revised downward to 3.3 percent for this year, 0.4 percentage point lower than in the April 2014 World Economic Outlook (WEO). The global growth projection for 2015 was lowered to 3.8 percent.

The global recovery continues to be uneven, with some countries and areas struggling, while others move forward into growth.

Downside risks are increasing and include –

SHORT TERM: worsening geopolitical tensions (Ukraine, Syria) and reversal of recent risk spread and volatility compression in financial markets

MEDIUM TERM: stagnation and low potential growth in advanced economies (Eurozone flirting with deflation) and a decline in potential growth in emerging markets

Organization of Economic Cooperation and Development (OECD) Projections

The OECD Economic Outlook Advance Release for the G-20 from October 2014 projects the following growth rates for 2014 and 2015 (click to enlarge).

OECDgraphic

For total global GDP growth, the OECD projects 3.3 percent for 2014 and 3.7 percent for 2015 or 0.1 percent less for 2015 than the IMF.

Chinese economic growth is ratcheting down from double-digit levels several years ago, to around 7 percent, while Indian GDP growth is projected to stay in the 6 percent range.

There are significant differences in the IMF and OECD forecasts for the United States.

Survey of Professional Forecasters

The Survey of Professional Forecasters (SPF) is another publically available set of macroeconomic forecasts, but focusing on the US economy. The SPF is maintained by the Philadelphia Federal Reserve Bank, which polls participating analysts quarterly, compiling consensus results, spreads, and distributions.

The latest SPF Survey was released August 2014, and is somewhat more optimistic about US economic growth than the IMF and OECD projections.

SPF3rdQ14

Investment Bank Data and Projections

Wells Fargo Securities Economics Group produces a monthly report with detailed quarterly forecasts for the US economy. Here is a sample from August 2014 (click to enlarge).

WFforecast

I’m compiling a list of these products and their availability.

The bottom line is there are plenty of forecasts to average together to gin up high likelihood numbers to plug into sales and other business forecast models.

At the same time, there is a problem with calling turning points in almost all these products.

This is not a problem on YouTube now, though. If you search “economic forecasts 2015” on YouTube today, you will see a lengthly list of predictions of economic collapse and market catastrophe by the likes of Jim Rogers, Gerald Calente, and others who dabble in this genre.

We need something like the canary in the coal mine.

comp

Predicting the Midterm Elections

Predicting the outcome of elections is a fascinating game with more and more sophisticated predictive analytics.

The Republicans won bigtime, of course.

They won comfortable control of the US Senate and further consolidated their majority in the House of Representatives.

Counting before the Louisiana runoff election, which a Republican is expected to win, the balance is 52 to 44 in the Senate, highlighted in the following map from Politico.

senateresults

In the US House of Representatives, Republicans gained 12 seats for a 57 percent majority, 244 to 184, as illustrated in a New York Times graphic.

houseresults

Did Anyone See This Coming?

Nate Silver, who was prescient in the 2012 General Election, issued an update on his website FiveThirtyEight on November 4 stating that Republicans Have A 3 In 4 Chance Of Winning The Senate.

And so they did win.

Salon’s review of Silver’s predictions notes that,

Overall, the candidate with better-than-even odds in FiveThirtyEight’s model won or is likely to in 34 of the 36 Senate contests this year, for a success rate of 94 percent.

The track record for the governorships was less shining, with upsets in Maryland and Kansas and several wins by candidates with unfavorable odds in the FiveThirtyEight lineup.

Bias in Polls

Silver’s forecasting model weighs both polling data and fundamentals- like demographics.

After the election, Silver blamed some of his mistakes on bias in polls, claiming that, this time, the Polls Were Skewed Toward Democrats.

Based on results as reported through early Wednesday morning …. the average Senate poll conducted in the final three weeks of this year’s campaign overestimated the Democrat’s performance by 4 percentage points. The average gubernatorial poll was nearly as bad, overestimating the Democrat’s performance by 3.4 points.

He backs this up with details of bias in polls by race, and, interestingly, throws up the following exhibit, suggesting that there is nothing systematic about bias in the polls.

biaspolls

Here is another discussion of mid-term election polling error – arguing it is significantly greater during midterms than in Presidential election years.

While not my area of expertise (although I have designed and analyzed survey data), I’m think the changing demographics of “cell-only” voters, no-call lists, and people’s readiness to hang up on unsolicited calls impacts the reliability of polling data, as usually gathered. What Silver seems to show with his graphic above, is that adjusting for these changes causes another form of unreliability.

money

The End of Quantitative Easing, the Expansion of QE

The US Federal Reserve Bank declared an end to its quantitative easing (QE) program at the end of October.

QE involves direct Fed intervention into buying longer term bonds with an eye to exercising leverage on long term interest rates and, thus, encouraging investment. Readers wanting more detail on how QE is implemented – check Ed Dolan’s slide show Quantitative Easing and the Fed 2008-2014: A Tutorial

The New York Times article on the Fed actions – Quantitative Easing Is Ending. Here’s What It Did, in Charts – had at least two charts that are must-see’s.

First, the ballooning of the Federal Reserve Balance sheet from less than $1 trillion to $4.5 trillion today –

FedQEassets

Secondly, according to Times estimates, about 40 percent of Fed assets are comprised of mortgage-backed securities now – making the Fed a potential major player in the US housing markets.

MBS

Several recent articles offer interpretation – what does the end of this five-year long program mean for the US economy and for investors. What were the impacts of QE?

I thought Jeff Miller’s “Old Prof” compendium was especially good – Weighing the Week Ahead: What the End of QE Means for the Individual Investor. If you click this link and find a post more recent than November 1, scroll down for the QE discussion. Basically, Miller thinks the impact on investors will be minimal.

This is also true in the Business Week article The Hawaiian Tropic Effect: Why the Fed’s Quantitative Easing Isn’t Over

But quantitative easing is the gift that keeps on giving. Even after the purchases end, its effects will persist. How could that be? The Fed will still own all those bonds it bought, and according to the agency itself, it’s the level of its holdings that affects the bond market, not the rate of addition to those holdings. Having reduced the supply of bonds available on the market, the Fed has raised their price. Yields (i.e. market interest rates) go down when prices go up. So the effect of quantitative easing is to lower interest rates for things Americans actually care about, such as 30-year fixed-rate mortgages.

Some other articles which attempt to tease out exactly what impacts QE did have on the economy –

Evaluation of quantitative easing QE had “some effects” but it’s one of several influences on the bond market and long term interest rates.

Quantitative easing: giving cash to the public would have been more effective

QE has also had unforeseen side-effects. The policy involved allowing banks and other financial institutions to exchange bonds for cash, and the hope was that this would lead to improved flows of credit to firms looking to expand. In reality, it encouraged financial speculation in property, shares and commodities. The bankers and the hedge fund owners did well out of QE, but the side-effect of footloose money searching the globe for high yields was higher food and fuel prices. High inflation and minimal wage growth led to falling real incomes and a slower recovery.

What Quantitative Easing Did Not Do: Three Revealing Charts – good discussion organized around the following three points –

  1. QE did not work according to the textbook model
  2. QE did not cause inflation
  3. QE was not powerful enough to overcome fiscal restraint

Expansion of QE

But quantitative easing as a central bank policy is by no means a dead letter.

In fact, at the very moment the US Federal Reserve announced the end of its five-year long program of bond-buying, the Bank of Japan (BOPJ) announced a significant expansion of its QE, as noted in this article from Forbes.

Last week, as the Federal Reserve officially announced the end of its long-term asset purchase program (commonly known as QE3), the Bank of Japan significantly ratcheted up its own quantitative easing program, in a surprising 5-4 split decision. Starting next year, the Bank of Japan will increase its balance sheet by 15 percent of GDP per annum and will extend the average duration of its bond purchases from 7 years to 10 years. The big move by Japan’s central bank comes amid the country’s GDP declining by 7.1% in the second quarter of 2014 (on an annualized basis) from the previous quarter following the increase of the VAT sales tax from 5% to 8% in Japan earlier this year and worries that Japan could fall into another deflationary spiral..

The scale of the Japanese effort is truly staggering, as this chart from the Forbes article illustrates.

 CentralBankAssets

The Economist article on this development Every man for himself tries to work out the implications of the Japanese action on the value of the yen, Japanese inflation/deflation, the Japanese international trade position, impact on competitors (China), and impacts on the US dollar.

What about Europe? Well, Bloomberg offers this primer – Europe’s QE Quandary. Short take – there are 18 nations which have to agree and move together, Germany’s support being decisive. But deflation appears to be spreading in Europe, so many expect something to be done along QE lines.

If you are forecasting for businesses, government agencies, or investors, these developments by central banks around the world are critically important. Their effects may be subtle and largely in unintended consequences, but the scale of operations means you simply have to keep track.

bubble

Forecasting the Downswing in Markets – II

Because the Great Recession of 2008-2009 was closely tied with asset bubbles in the US and other housing markets, I have a category for asset bubbles in this blog.

In researching the housing and other asset bubbles, I have been surprised to discover that there are economists who deny their existence.

By one definition, an asset bubble is a movement of prices in a market away from fundamental values in a sustained manner. While there are precedents for suggesting that bubbles can form in the context of rational expectations (for example, Blanchard’s widely quoted 1982 paper), it seems more reasonable to consider that “noise” investors who are less than perfectly informed are part of the picture. Thus, there is an interesting study of the presence and importance of “out-of-town” investors in the recent run-up of US residential real estate prices which peaked in 2008.

The “deviations from fundamentals” approach in econometrics often translates to attempts to develop or show breaks in cointegrating relationships, between, for example, rental rates and housing prices. Let me just say right off that the problem with this is that the whole subject of cointegration of nonstationary time series is fraught with statistical pitfalls – such as weak tests to reject unit roots. To hang everything on whether or not Granger causation can or cannot be shown is to really be subject to the whims of random influences in the data, as well as violations of distributional assumptions on the relevant error terms.

I am sorry if all that sounds kind of wonkish, but it really needs to be said.

Institutionalist approaches seem more promising – such as a recent white paper arguing that the housing bubble and bust was the result of a ..

supply-side phenomenon, attributable to an excess of mispriced mortgage finance: mortgage-finance spreads declined and volume increased, even as risk increased—a confluence attributable only to an oversupply of mortgage finance.

But what about forecasting the trajectory of prices, both up and then down, in an asset bubble?

What can we make out of charts such as this, in a recent paper by Sornette and Cauwels?

negativebubble

Sornett and the many researchers collaborating with him over the years are working with a paradigm of an asset bubble as a faster than exponential increase in prices. In an as yet futile effort to extend the olive branch to traditional economists (Sornette is a geophysicist by training), Sornette evokes the “bubbles following from rational expectations meme.” The idea is that it could be rational for an investor to participate in a market that is in the throes of an asset bubble, providing that the investor believes that his gains in the near future adequately compensate for the increased risk of a collapse of prices. This is the “greater fool” theory to a large extent, and I always take delight in pointing out that one of the most intelligent of all human beings – Isaac Newton – was burned by exactly such a situation hundreds of years ago.

In any case, the mathematics of the Sornette et al approach are organized around the log-periodic power law, expressed in the following equation with the Sornette and Cauwels commentary (click to enlarge).

LPPL

From a big picture standpoint, the first thing to observe is that there is a parameter tc in the equation which is the “critical time.”

The whole point of this mathematical apparatus, which derives in part from differential equations and some basic modeling approaches common in physics, is that faster than exponential growth is destined to reach a point at which it basically goes ballistic. That is the critical point. The purpose of forecasting in this context then is to predict when this will be, when will the asset bubble reach its maximum price and then collapse?

And the Sornette framework allows for negative as well as positive price movements according to the dynamics in this equation. So, it is possible, if we can implement this, to predict how far the market will fall after the bubble pops, so to speak, and when it will turn around.

Pretty heady stuff.

The second big picture feature is to note the number of parameters to be estimated in fitting this model to real price data – minimally constants A, B, and C, an exponent m, the angular frequency ω and phase φ, plus the critical time.

For the mathematically inclined, there is a thread of criticism and response, more or less culminating in Clarifications to questions and criticisms on the Johansen–Ledoit–Sornette financial bubble model which used to be available as a PDF download from ETC Zurich.

In brief, the issue is whether the numerical analysis methods fitting the data to the LPPL model arrive at local, instead of global maxima. Obviously, different values for the parameters can lead to wholly different forecasts for the critical time tc.

To some extent, this issue can be dealt with by running a great number of estimations of the parameters, or by developing collateral metrics for adequacy of the estimates.

But the bottom line is – regardless of the extensive applications of this approach to all manner of asset bubbles internationally and in different markets – the estimation of the parameters seems more in the realm of art, than science, at the present time.

However, it may be that mathematical or computational breakthroughs are possible.

I feel these researchers are “very close.”

In any case, it would be great if there were a package in R or the like to gin up these estimates of the critical time, applying the log-periodic power law.

Then we could figure out “how low it can go.’

And, a final note to this post – it is ironic that as I write and post this, the stock markets have recovered from their recent swoon and are setting new records. So I guess I just want to be prepared, and am not willing to believe the runup can go on forever.

I’m also interested in methodologies that can keep forecasters usefully at work, during the downswing.

Sales and new product forecasting in data-limited (real world) contexts