"Kee" Points with Jim Kee, Ph.D.

The US economy continues to plod along, while the international data shows improvement (from deceleration to plodding along!). The biggest concern right now is the recent housing data. Specifically, mortgage applications have been cut in half since interest rates began rising (Capital Economics) and new home sales fell 13% in July. But viewed over the past several years, home purchases are already low, so this looks like continued muddling to me. Housing is definitely important to watch, because residential construction is statistically the strongest predictive component for next quarter’s GDP. In fact, the housing component of last quarter’s GDP has twice the predictive power as last quarter’s GDP itself! So I watch housing starts. They have jumped up since 2011 from a very low level (turning down recently) but are still, historically, at recession levels.

Here’s one way to put it all together: Remember, most expansions are led by housing and autos, the truly discretionary components of consumer spending. The current expansion has been different; housing and autos were on the their backs in the early part of this expansion, but business investment spending and exports were much stronger than usual, so they took up the slack. Then, as exports and business spending started to slow, housing and autos picked up. That’s why if housing does continue slow, I hope to see exports and business investment spending improving. Those are the things to watch and why.

Europe and “the most interesting thing I saw last week”:  For decades, academic researchers have attempted to partition the performance of companies and of different assets according to country effects, industry or sector effects, etc. For example, it is important for the purposes of management compensation to try to figure out how much of a company’s earnings (profits) or stock price performance was due to company-specific or management actions, versus just being in the right industry at the right time, or from just being located (domiciled) in the right country at the right time (i.e. “not Europe” during the past few years, or “not Asia” during the Asia currency crisis meltdowns). Naturally, the industry and country effects vary from one time period to another.

The Financial Times had what I felt was one of the more interesting articles on Europe last week. The article pointed out that, as the danger of break-up in Europe has faded, sector effects are for the first time since the crisis becoming more important than country effects. Specifically, one key to investing in Europe, or minimizing the pain of being invested in Europe, was to avoid the troubled countries and instead stay with the healthier ones, regardless of what industry you were investing in. Now industry effects are becoming more important, while country effects are receding. That continues a general pattern seen more broadly over time with global integration. That is, as the world becomes more integrated, country effects or diversification (where you invested) should become less important relative to sector effects (what sectors you are invested in). Of course, it is never really that clear and simple, even in Europe today, but those are some tendencies that I think are helpful for understanding the world. And it also seems that the relative importance of sector versus country effects in Europe shouldbe a good gauge as to how progress in Europe is going.