April 29, 2013
For the economist, one of the most dangerous urges is to fall in love with our forecast. That is to say, to become so wedded to our own world view that we are blind to the changes evident all around us and the effect we could have on our own preconceived notions about how the world works.
Economists like to think we can make a decent stab at forecasting what is coming down the track. For many, our reputation gets caught up in this forecast and, rather than admit our forecast is going badly off track as the data changes, we stick to it in the hope that the evidence will change to substantiate our earlier prejudices.
Keynes, of course, was wise to this and he covered all bases when he responded to questions as to why he wasn’t right all the time with the deliciously humble quip: “When the facts change, I change my opinions. What do you do, sir?”
In the world of investing, the economist who falls in love with his own forecast is a very dangerous character and is liable to lose lots of both his own money and the money of those who placed their loot in his trust.
At the moment, world financial markets are at a type of crossroads because the global economy is losing altitude progressively yet the stock markets keep rising strongly. This should not be the case. The stock market should only be the aggregation of all the future profits of all the companies in the world. Therefore, if the stock markets are going up, the implication should be that the global economy should be entering a new growth phase.
Yet this is not the case. Latest data from the US released last Friday reveal that the economy there is growing more slowly than expected. This comes on top of last week’s news that the US isn’t producing as many jobs as people expected. In the past month, 68 per cent of the data releases from the US have been below expectations, underlining that the economy is weakening more quickly than the experts had forecast.
In Europe, things are worse. We know – notwithstanding Angela Merkel’s mischievous words on Germany needing higher interest rates, while the rest of the EU needed lower ones – that Europe’s economy is on the canvas. (We will come back to Frau Merkel later).
Last week, Spain and France saw rising levels of unemployment. In France, jobless claims have risen for 23 months in a row.
There are one million more people unemployed today in Spain than there are people living on the island of Ireland – north and south. This is a phenomenal figure and gives you some idea of what is going on in Europe. The fact that Merkel believes that an interest rate rise might now be the best thing for Germany underscores just how dysfunctional the monetary union is.
Noises out of China point to the fact that the growth rate is falling gradually – which is not that hard to understand because, after all, if the two biggest economies in the world – Europe and the US – are retrenching, who is China going to sell stuff to?
Now this is where the recent rallies in the stock markets become more perplexing. If the economies are slowing how could the stock markets be rallying? And, more interesting, if the stock markets are rallying, should the prices of raw material be going up too?
The raw material that is among the most linked to GDP and future industrial production is copper. Copper is used in everything.
Copper is used in building construction, power generation and transmission, electronic product manufacturing and the production of industrial machinery and transportation vehicles. Copper wiring and plumbing are integral to the appliances, heating and cooling systems, and telecommunications links used every day in homes and businesses. Copper is an essential component in the motors, wiring, radiators, connectors, brakes and bearings used in cars and trucks.
According to the US geological survey, “the average car contains 1.5 kilometres of copper wire, and the total amount of copper ranges from 20 kilograms in small cars to 45 kilograms in luxury and hybrid vehicles”.
Copper is all around us – the Statue of Liberty represents one of the largest uses of copper in a single structure. To build the statue, about 80 tons of copper sheet was cut and hammered to a thickness of about 2.3 millimetres.
So if the global economy is improving as the stock markets are predicting, the price of copper should be going through the roof, no?
Now look at the chart. It plots the recent price of copper and the recent moves in the Dow Jones average.
The red-and-black line on the chart tracks the spot price of copper going back to last November. The black line tracks the price rise of the S&P 500. Copper prices have fallen off the proverbial cliff. But the S&P 500 – which the press insists is responding to a “recovery” in the global economy – has managed to stay afloat. Given that copper has the highest sensitivity to economic growth and is therefore a useful leading indicator for cyclical shifts in the global economy, this is worth paying attention to.
The disparities between the price of copper and the stock markets are being termed by some of the smarter financial analysts such as Bill Bonner of thedailyreckoning.com as the “great divergence.”
The bond market also sees little growth and disinflation ahead. This is measured by the fact that yields on all bonds are falling and have been for many months.
Bond investors clearly have a different view of what’s coming down the road than equity investors. Bond investors see unemployment, low inflation and low growth. Equity investors see profits, strong demand, high growth and good times ahead. The price of copper and other essential commodities are screaming a collapse in demand and industrial output.
And yet, in Europe, Merkel is predicting that a rise in German interest rates may be appropriate and in America, the Federal Reserve has quadrupled the size of its balance sheet and kept real interest rates negative for longer than any period since the early 1970s.
If you find all this confusing, so do I. The only answer is not to fall in love with your own view of the world.
We are at a crossroads: some indicators say all will be fine, others scream that we are going over a cliff. The best advice in these confused times is “be careful, be very, very careful”. When an economist suggests that he is very confident about what’s going to happen in the next year or two, look around for a large pinch of salt.