Is NYSE investor credit a signal?

There is always a point when too much credit leads to a market correction. There is a tipping point and we may be at another one when you look at NYSE investor credit. Unfortunately a close look at the graph shows that the tipping point will change. We are at credit extremes but if you used past tipping points you would have been a net loser. The market moves higher and negative credit balances continue to grow. What is going on here?

Jackson Hole fall-out

Walked through all of the Jackson Hole papers and came to the conclusion is that theme of labor markets was very appropriate at this time and that all said the conflicting evidence between cyclical and structural issues are real. Yet, the take away from all of these papers is that labor markets are going through structural change and credit policies may not solve all the problems seen on the Yellen dashboard. Simply put, labor problems cannot be solved through monetary policy alone and going it alone may have major negative ramifications.

However, if you believe in the precautionary principle for making decisions, it may not make sense to raise rates and be the Fed Chairman who stopped the poor recovery. (One could argue that the precautionary principle could be a good reason to raise rates but that is for another discussion.) The bias still seems for a delay in a rate increase given there is the continued counter-factual view that if a zero rate with QE was not tried the economy could be worse off.

The complexity of labor markets was presented in all of the papers. For example, the Davis Haltiwanger paper on labor fluidity suggests that labor markets are changing because there is less mobility. There is less reallocation and churn in jobs which makes for higher unemployment for the young, old, and marginal worker. This is a structural issue.

Autor provides an analysis of real wages which suggests that the flattening of wage growth began before the financial crisis which again suggests a structural issue.The exception was for those with advanced degrees.

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The panel on demographics reported evidence that again the employment problem is structural. However, Song and von Wachter provide an interesting study that suggests that the long-term unemployment in the Financial Crisis may not be dissimilar for other recessions. This may suggest that counter-cyclical policies have and can work to alleviate labor  problem. Bertola presents evidence on labor elasticities across countries and show sthat labor rigidities have an important impact on employment levels.

The stories are all of the same. The labor markets are complex and the transmission between monetary policy and hiring is not clear.

Yield gap models and equity allocations

The yield gap model is an important tool for determining valuation in  equities. You just have to look at the yield on a long-term Treasury versus the earnings yield of a stock index. There have been problems with this type of model,  but it generally works as a good simple pass on the data. If the earnings yield is higher than bond yields buy equities. If bond yields are higher than earnings yield buy debt. If the yield gap gets larger, then hold less equity. This allocation can be mapped into a set of equity and bond weights.

A simple problem with this simple model is that is does not account for the yield curve. You are not accounting for the price of money through time. We know that the yield curve tells us a lot about the economy. An inverted yield curve will usually precede a recession. The yield gap in a short-term rate can be compared with the yield gap of a long-term rate. If there is a significant difference between the two, it tells us that there is a difference in the shape of the yield curve. This can be used as an added signal for determining the market allocation. This type of model is used at BlackRock.

Of course, it could be used separately as a two part or dual model of yield gap and yield curve instead of a combination of two yield gap models which switches based on the difference between the yield gap model. The yield gap or Fed-type models have had a mixed history, but still seems to be an easy way to provide a first pass at relative value that can be employed by most investors. 

Yellen at Jackson Hole and transparecy

The buzzword from central banks for years has been transparency, yet here we are post-Jackson Hole waiting for Chairman Yellen to again say something important about policy. We don't know what the rules will be for changes in rates. Policy should not work this way. It should not be a balance of pros and cons based on a speech. It should be translated to action through clear rules. The verbal should be employed to explain why the rules are not being followed. It should be the exception not the norm. 

In the 60's and 70's pre-rational expectations, there was the belief that economists could engineer changes in the economy and that we could employ optimal control to solve monetary problems. The Lucas critique and the rational expectations revolution changed that thinking. It was argued that transparency was needed to reduce uncertainty but policy models for engineering an economy would not work. 

Still, we are now at an extreme that there is no model for how transparency will work. Fed officials tells us about their transparency, but then cannot articulate a clear policy. Talking without clarity is not transparency. The discussion for the 80's and 90's was about Fed creditability but what is the level of creditability when you do not know what are the decision rules.