Political Calculations
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October 22, 2014

Since we're now outside of the anniversary period of 2013's U.S. debt ceiling crisis, the third and smallest of the major noise events of 2013, we're making the transition back to using our standard baseline model for use in forecasting and explaining changes in current day stock prices. Something that people like Catherine Rampell would not appear to believe is even possible.

Even though the period from 1 October through 17 October is somewhat affected by the echo effect's impact on our mathematical model of how stock prices work, it's pretty small in size. That's certainly true after we substitute the CBOE's dividend futures value for 2014-Q3 (of $9.895 per share) that we were previously using in our projections with S&P's final reported value for the quarter's dividends (of $10.023 per share). This change accounts for the upward shift in the trajectory associated with investors focused on the distant future quarter of 2015-Q3 compared to the version of this chart that we last posted.

Alternative Futures - Standard Baseline Model - Fourth Quarter 2014 - Snapshot on 21 October 2014

What we observe is consistent with stock prices either rebounding to the level that investors focused on 2015-Q3 would set them after having "overcorrected" for the misplaced rally of 8 October 2014, or perhaps more likely, briefly focusing on 2015-Q1, which could have been influenced by the earnings being reported by U.S. companies during the past week.

In both cases, to the dismay of the Rampells of the world, the current state of the U.S. economy carries no weight in the setting of stock prices, as investors are almost invariably looking beyond the present quarter as they make their investment decisions.

In fact, it's really pretty rare for investors to maintain any sort of focus on the current quarter in setting stock prices for any sustained period of time. There are really only two periods during the past six years where we've observed that sort of thing, which occurred when U.S. companies were either slashing their dividends in the current quarter, which played out as the crash from 26 September 2008 through 9 March 2009) or were acting to significantly boost their dividend payments to investors (15 November 2012 through 20 December 2012), where they were raiding the funds set aside to pay dividends in future quarters to beat the clock on the risk of major tax hikes as part of the Fiscal Cliff Crisis.

And since its the changes in the growth rate of dividends that are directly proportional to the changes subsequently seen in the growth rate of stock prices as they respond to this fundamental signal as investors collectively focus on particular points of time in the future in making their investment decisions, let's take a look at what those expectations specifically are:

Changes in the Growth Rates of Expected Future Trailing Year Dividends per Share with Daily and 20-Day Moving Average of S&P 500 Stock Prices, Through 21 October 2014

Looking forward, here is the level of dividends for the S&P 500 that investors are currently expecting to be paid in each of the following future quarters (according to the CBOE's dividend futures contracts as of 21 October 2014):

  • 2014-Q4: $9.886 per share (*)
  • 2015-Q1: $10.743 per share (*)
  • 2015-Q2: $10.619 per share
  • 2015-Q3: $10.712 per share

(*) All these values are based on dividend futures contracts, which run from the end of the preceding futures contract on the third Friday of the month ending the preceding quarter through the third Friday of the month ending the indicated quarter, and which project the dividends per share that will be paid out over that interval. These values will not match those reported by Standard and Poor for the S&P 500, since they report the dividends paid from the end of the month for one calendar quarter to the end of the next. Because of that difference, and because a lot of companies pay out their largest dividends before the end of the year, look for significant discrepancies between the CBOE's dividend futures and S&P's reported dividends for Q4 and Q1, with lesser adjustments for Q2's and Q3's dividends.

What these values do however tell us is that investors are expecting flat to lower dividend growth once we're in 2015. Which is why stock prices are most likely to head sideways or lower in the absence of an improving economic situation in the future that would prompt companies to boost their dividends in those future quarters.

What's more, the Federal Reserve shares our basic assessment, which we discovered in the reporting on the one topic that could suddenly cause investors to focus on the current quarter of 2014-Q4 in setting today's stock prices:

Mr. Bullard did not say he definitely wanted to extend the bond-buying program. No other Fed official has offered such speculation, and three—Boston Fed President Eric Rosengren, San Francisco Fed President John Williams and Dallas Fed President Richard Fisher—said in recent days they expect to end the purchases at their meeting Oct. 28-29.

The Fed’s policy committee has said recently the bond program would end this month. Barring a really tumultuous final 10 days of October, the panel “will almost certainly make that forecast come true,” analysts at Wrightson ICAP said.

More broadly, Fed officials routinely reject the idea they target stock prices in their policy deliberations. To the extent an equity fall would influence policy makers, it would have be very sharp and threaten to destabilize the financial system and the broader economy.

No comments from Fed officials over recent weeks have suggested officials are overly alarmed about what’s been happening in markets. Mr. Fisher even welcomed the declines as a sign markets are pricing equities in better alignment with the economy’s fundamentals.

WSJ reporter Michael Derby forgot to add the words "going forward" to the end of that last sentence, because those are the economic fundamentals that matter where stock prices are concerned. For people who pay attention to stock prices, the present is only where we live.

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October 21, 2014

Who were the major holders of debt issued by the U.S. federal government as of the end of its 2014 fiscal year?

The preliminary answer of who owns the $17.860 trillion in debt issued by the U.S. federal government as of 30 September 2014 is presented graphically below:

Fiscal Year 2014: To Whom Does the U.S. Government Owe Money?

The data for foreign holdings will be revised over the next six months. We anticipate that the holdings indicated for Belgium will be shifted to other foreign entities, given that nation's role as an international banking center.

Since FY2013

Since the end of the U.S. government's 2013 fiscal year on 30 September 2013, the total public debt outstanding for the U.S. government has increased by $1.086 trillion (or to agree with the units shown on our chart, $1,086 billion). That would mark the sixth time in the last seven years that the national debt of the United States has expanded by more than $1 trillion dollars per year - double the typical half trillion a year increases that were viewed as a major problem prior to Barack Obama's presidency.

Year Over Year Changes in the U.S. National Debt (Total Public Debt Outstanding), Fiscal Years 2000-2014

The $1.086 trillion increase in the total national debt for Fiscal Year 2014 is all the more remarkable because the U.S. Treasury Department just bragged that the federal government's budget deficit for FY2014 was $483 billion.

Oct 15 (Reuters) - The U.S. budget deficit fell by nearly a third to $483 billion in fiscal 2014, the lowest level since 2008, as a quickening economic recovery boosted tax collections and spending grew only modestly, the Treasury Department said.

The deficit, down from $680 billion last year, was the lowest since a $459 billion budget gap in fiscal 2008, which was followed by four straight years of $1 trillion-plus deficits in the wake of the financial crisis.

U.S. Treasury Secretary Jack Lew and White House Budget Director Shaun Donovan hailed the data on Wednesday as a "return to fiscal normalcy" as the 2014 deficit fell to 2.8 percent of gross domestic product. That was the lowest since 2007 and a smaller share of the economy than the annual average for the last 40 years.

Somehow, the U.S. federal government managed to borrow and spend an additional $603 billion, above and beyond the official budget deficit of $483 billion claimed by the Obama administration, in order to cause the national debt to increase by more than one trillion dollars in one year.

How Could That Happen?

Part of the answer lies in the debt ceiling debate during 2013, which ultimately led to the partial federal government shut down for the first 17 days of the 2014 fiscal year, from 1 October 2014 through 17 October 2014.

Here, U.S. Treasury Secretary Jack Lew artificially kept the U.S.' total public debt outstanding from increasing above the statutory debt ceiling by shifting around the portion of debt held by U.S. government entities, such as Social Security's Trust Fund and the U.S. Civil Service Retirement Fund - giving them I.O.U.s as he redirected funds intended for them to instead allow the U.S. Treasury to continue rolling over the debt it owes to the public.

The reason the U.S. government had to go through a partial shut down is because those trust funds didn't have enough money to keep the shell game going until the debt ceiling was increased. When it finally was, the U.S. government "owed" some $328 billion to "itself". Which it promptly rushed out to borrow in Fiscal Year 2014.

That's also why the increase in the national debt for FY2013 seems so low. $328 billion of the debt that should have been recorded in that year was actually recorded in FY2014.

That means that the U.S. national debt increased by $758 billion in FY2014, $275 billion more than the official amount of the U.S. Treaury's claimed $483 billion budget deficit.

We're still waiting for the official explanation of that fiscal discrepancy.

Data Sources

Federal Reserve Statistical Release. H.4.1. Factors Affecting Reserve Balances. 1 October 2014. [Online Document]. Accessed 17 October 2014.

U.S. Treasury. Major Foreign Holders of Treasury Securities. Accessed 17 October 2014.

U.S. Treasury. Monthly Treasury Statement of Receipts and Outlays of the United States Government for Fiscal Year 2014 Through September 30, 2014. [PDF Document].


October 20, 2014

Since the S&P 500 is behaving so predictably, and because we just visited the topic on Thursday, 16 October 2014, we thought we'd take this opportunity to revisit how the stock prices of the S&P 500 behaved in the third quarter of 2014.

Our first animated chart shows how stock prices behaved with respect to our standard baseline model, in which we incorporate the historic stock prices of one year earlier as the base reference points from which we project stock prices in the near term future:

Alternative Futures of S&P 500 Stock Prices, 2014-Q3, Standard Baseline Model

Since we knew coming into the quarter that our standard baseline model's projections would be skewed off as a result of what we call the echo effect, where the echoes of past noise events show up in our current day projections, we developed our rebaselined model, in which we exchanged the historic stock price data of a year ago for the historic stock data of two years ago - a period of time that was relatively free of the kind of noise events that can throw off our projections of future stock prices.

That simple change produced very good results, as demonstrated in the animated chart of our rebaselined model for the third quarter of 2014:

Alternative Futures of S&P 500 Stock Prices, 2014-Q3, Rebaselined Model

All in all, if you knew how far forward investors were looking in setting today's stock prices, and also when they were shifting their attention from one point of time in the future to another, 2014-Q3 was a pretty predictable quarter.

Speaking of which, let's look under the hood at the fundamental driver of stock prices: the changes in the rates of growth of dividends expected at discrete points of time in the upcoming future:

Change in the Growth Rates of Expected Future Trailing Year Dividends per Share with Daily and 20-Day Moving Average of S&P 500 Stock Prices, through 17 October 2014

Mind the notes in the margin of our expectations chart.

On a final note, we'll observe that the projections of our rebaselined model will begin to skew off from the actual trajectory of stock prices as it will be affected by the echo effect beginning in November, thanks to the two year anniversary of the noise events that resulted from the outcome of the 2012 U.S. election. The cool thing is that we now have the ability to effectively work around that kind of challenge in using our analytical methods, which is really what we demonstrated during the third quarter of 2014.

To find out more, follow the links below....

Previously on Political Calculations

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October 17, 2014
Chicago White Sox Pitcher Eddie Cicotte, 1917 - Source: Library of Congress - http://www.loc.gov/pictures/resource/ggbain.50311/

What if income inequality theorists got their way and stopped income inequality from ever increasing? What would be the result of that kind of achievement?

We came across the results of a unique experiment that was conducted nearly 100 years ago that answers the question, where a predefined level of income inequality was strictly enforced upon a small group of individual laborers with an outcome that permanently affected not just their jobs but also a national institution.

The experiment was unknowingly conducted by the professional baseball team owner Charles Comiskey, who after assembling "the best team money could buy", ultimately produced the most significant act of corruption in American sports history as a direct result of his strict enforcement of a policy of income equality upon his players regardless of their talent or individual contributions to the team's success: the Chicago Black Sox Scandal, in which a number of players on the 1919 Chicago White Sox deliberately lost the 1919 World Series to the Cincinnati Reds in return for payoffs from professional gamblers looking to gain from advance knowledge of the outcome.

Bruce Lowitt describes how the equality of income imposed by Charles Comiskey actually generated the worst possible outcome for everyone involved:

There was good reason the Sox were susceptible to the lure of quick money. They were among the American League's best players but Charles Comiskey paid most of them no more than the worst. The promised bonus for winning the 1917 pennant was a case of cheap champagne. Before the 1919 season, Comiskey promised Cicotte an extra $10,000 if he won 30 games. When Cicotte reached 29, Comiskey benched him. Player resentment was rampant.

Here, we see a prime example of the extreme penalty that Comiskey imposed upon one of his star players, pitcher Eddie Cicotte, to ensure that he would not ever be paid any more than any other player on the team, as Comiskey effectively imposed a 100% marginal income tax upon Cicotte as he came too close to becoming too successful in Comiskey's eyes.

What happened in response to that event would ultimately and permanently change America's national pastime as that achievement in preventing an increase in income inequality inspired acts of extreme corruption by eight players on the team, who wanted to have their pay reflect their real relative level of productivity and contribution to the team's success. And by "extreme corruption", we're not kidding. They threw the World Series, deliberately losing to the Cincinnati Reds in return for payoffs from professional gamblers.

Range of Annual Salaries for Seven Chicago White Sox Players Involved in the Black Sox Scandal in 1919 and 1920

But what's really curious is what happened after the World Series ended, because it was some time before the scandal was sorted out. Here, seven of the players involved in the scandal were signed to new contracts with the White Sox to play for the team in 1920, the year after the scandal, where they received anywhere from a 21% to a 100% increase in their previous year's salaries.

That's an especially curious thing because it is clear that Charles Comiskey was aware that the seven players had very likely deliberately lost the 1919 World Series before the contracts were negotiated. He could have refused to negotiate with the players suspected of corruption, but instead, he recognized that his previous policy for more equalized player pay was an abject failure and gave in to the greater level of income inequality demanded by the players in return for their real contributions to the team's success.

In 1919, the salaries for these seven players had ranged between a low of $2,750 to $6,000, a spread of $3,250, with the top income set at 218% of the income of the lowest paid player involved in the scandal. But in 1920, the player's incomes ranged from $3,200 to $10,000 (for Cicotte, who was paid $5,000 in 1919): a spread of $6,800, more than double what it had been in 1919, with the top income growing to be 312% of the lowest.

The Chicago White Sox went on to finish second in the American League in 1920, as the team's hitting and pitching was strong, finishing just two games behind the Cleveland Indians who had a stellar year. Increasing the income inequality among the team's players did not harm their performance as they achieved honest success - even winning eight more games than they had in the 1919 season (the 1920 season was 14 games longer than the 1919 season).

That's the benefit of increasing income inequality - a more honest system for rewarding the real contributions of the most productive members of a society. The penalties imposed by a system that rigorously imposes equality will almost invariably lead to corruption.

After the 1920 season, the news of the scandal broke break wide open, with the ultimate outcome that the eight Chicago White Sox players who had participated in the conspiracy to deliberately lose the 1919 World Series were banned from the sport of baseball for life, as the league's new, indepedent commissioner took actions to eliminate the potential influence that gambling could have in order to boost the sport's integrity.

But that is a whole separate issue from what really caused the scandal!

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October 16, 2014

This may surprise a lot of people, mainly because it stands in such contrast to the work product of their journalistic peers, but a lot of financial reporting is pretty well done.

But even financial journalists don't quite get the stories they cover 100% right. We have a great example of that today, featuring some really good reporting by Michael S. Derby of the Wall Street Journal, in which he does an excellent job describing why the stock market is selling off, but ends up putting the cart before the horse.

A world-wide equities sell off is driving investors to expect the Federal Reserve will wait longer to start raising short-term interest rates from near zero.

Participants in the fed funds futures market, where investors go to bet on possible movements in the Fed’s benchmark federal funds rate, shifted on Wednesday to project the central bank will begin raising interest rates sometime in the late third quarter or perhaps the fourth quarter of 2015.

Markets now see almost no chance of a Fed increase in rates coming next September, down from even odds a few weeks ago, said TD Securities economist Millan Mulraine in a note to clients. He noted investors are now putting a 50-50 chance on the Fed raising rates in October, and a 63% chance the move comes at the 2015 December Fed policy meeting.

The shift in market expectations comes as Fed officials are debating when to start raising rates. Several Fed officials expect lift off by the summer of 2015. Some want to move sooner and others want to wait until 2016.

Good reporting, but Derby gets it completely backwards at the very beginning. The sell off in stock prices most certainly did not drive investors to start expecting that the Fed would delay hiking interest rates until later in 2015. Instead, it is completely the other way around. The change in expectations that the Fed would delay hiking interest rates in the U.S. is what has caused stock prices to fall.

More specifically, that shift in expectations started to take place on Monday, 13 October 2014, and may be fully attributed to a speech that Federal Reserve minion Charles Evans gave to the National Council on Teacher Retirement on the subject of Monetary Policy Normalization: If Not Now, When? The timing of Evans' speech, and the dissemination of its content among Wall Street traders throughout the afternoon, directly coincides with the sudden shift of investors from focusing on 2015-Q2 in setting today's stock prices, to instead focus their attention on the more distant future quarter of 2015-Q3.

Here is what we noted in the update to our regular Monday post on that sudden shift in expectations later that day:

Update 13 October 2014, 8:20 PM EDT: Today's market action is what a shift in focus looks like - where investors suddenly shift their focus from one point of time in the future to another. Or, in terms of our rebaselined chart, from 2015-Q2 to 2015-Q3:

Alternative Futures for S&P 500, 30 September 2014 - 6 January 2015 (Rebaselined Model - Incorporates Historic Stock Price Data for Projections from Two Years Prior), Snapshot on 10 October 2014

As for why investors shifted their focus to 2015-Q3, well, that's easy. One of the minions at the Federal Reserve indicated that economic weakness would lead the Fed to delay those interest rate hikes, which for the Fed's game of expectations, had been set to occur in the middle of 2015. With evidence of a weakening economy in the present mounting, it wouldn't take much for investors to shift their attention further forward in time as they could reasonably believe the Fed will be forced to delay.

It's a small change, but one with an amplified impact upon stock prices given the nature of how they work.

Remarkably, stock prices are still within our forecast range for 13 October 2014 assuming that investors had been focused on 2015-Q2 in setting today's stock prices - we've gone from one extreme to the other in just a matter of days. Whether this change is just a temporary noise event or actually a sustained shift in focus will become evident over the next several days.

Update 14 October 2014 8:06 AM EDT: From the WSJ - Despite Mixed Risks in U.S., Rate Timing Hasn't Shifted Much. Indeed!

We've now had the next several days to see if that shift would be sustained. It has. In fact, despite one of the more volatile days in recent market history, the S&P 500 closed at a value that is fully consistent with investors having shifted their forward-looking focus to 2015-Q3. At least, according to our rebaselined model of how stock prices work:

Alternative Futures for S&P 500, 30 September 2014 - 6 January 2015 (Rebaselined Model - Incorporates Historic Stock Price Data for Projections from Two Years Prior), Snapshot on 15 October 2014

Up until Monday, the S&P 500 was largely tracking along with the trajectory associated with the expectations for 2015-Q2. In the previous weeks, that had meant a relatively steady decline in stock prices, with the exception of a very short-lived positive noise event on Wednesday, 9 October 2014, when investors were briefly distracted by a bright shiny object.

And then, Chicago Fed minion Charles Evans gave his speech, basically giving investors permission to anticipate that the recent onset of negative economic news indicating a deteriorating situation for the U.S. economy would lead the Fed to delay hiking short term interest rates until 2015-Q3, and that was all it took for stock prices to fall to the level they have.

In case you're wondering, it's having to cope with events like this that inspired us to include each of the trajectories that the S&P 500's stock prices are most likely to follow given how far forward in time investors are looking as they make their investment decisions today on our forecast charts.

So yes. It's almost as if we predicted it! Because we did. Because we can.

What we can't do, except in certain limited circumstances, is to anticipate in advance when such shifts in focus will occur. That aspect of how stock prices behave actually is random. It's a good thing that those factors are such a small part of what really drives stock prices.

In the meantime, even though it wasn't always true on 15 October 2014, by the closing bell, order was maintained in the stock market.

But will that last for very long? The suspense is terrible. We hope it will last!

On a closing note, looking back at the trading day that was, we can't help but think of Chicago Federal Reserve President Charles Evans' role in unleashing all that volatility. It is as if he were the very reincarnation of Mrs. O'Leary's cow....

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