Krugman, Cochrane, Altig ...

There is an active discussion of the future of economics profession. Where should we ( e.g. the broader scientific community) seek the ideas and tools, which could save economics as an emergent science?

Some mainstream economists like Krugman, Cochrane, Altig and others again discuss these problems in light of which school of economic thought should prevail. I guess that this discussion will stretch straight into the next failure to predict significant economic phenomenon; like deflation in the USA starting in 2012. So, despite its activity the discussion seems to be a hopeless one.

We deserve a better treat. Therefore, the scientific community must formulate clear questions and set some threshold requirements for economics as a science to be allowed to shape and control economic and social life. In a sense, we are all customers of economic theory because it ifluences in one way or another the decisions made by economic and financial authorities. As the customers we should ask the economic profession to formulate a new research plan (not to argue which school is wrong). This plan has to define clear (for general public and experts in various fields) ideas and tools which are necessary to answer the question why the theory has failed to describe 2007-2010, and when it expects a new unpredictable change likely to happen. Meanwhile, it would be helpful for economists to regain public trust. This current discussion on the difference between various (failed) approaches does not look like helpful. If they follow the route of the negation of the presence of educated audience waiting for reasonable answers, they will completely detach themselves from the scientific community and general public as well.

PPI of copper ores and grains: update. July and August 2009

Lately, we have demonstrated that the evolution of various components of CPI and PPI in the United States is not a random process but rather a predetermined one with long-term sustainable trends [1-4]. Using these trends, one can predict consumer and producer price indices for various goods, services and commodities [5-7]. Moreover, share prices for selected S&P 500 companies are also well described in the past by the differences in the PPI and CPI [8,9]. The near future will test the predictive power of our model.
In [4-7], we presented the evolution many commodities with varying weight in the PPI. But there are many more commodities of interest for producers, consumers and investors. In this article, we present the producer price indices of copper and grain. The evolution of the indices of these two commodities is independent, but both give a good example of the absence of clear sustainable trends. In other words, not every commodity price is predictable as an extension of a liner trend, as mentioned in [4]. However, in the short-term, there is observed some inertia in the evolution of both prices. Therefore, one can predict the indices at a several month horizon. On July 27, we published selected results of our study for June 2009. This is a bi-monthly update, which includes two new readings for July and August 2009. Both commodities demonstrate continuation of short-term trends. Supposedly, these trends survive till the end of 2009.
Figure 1 displays the overall (commodity) PPI and the index of copper ores since 1988. The difference of these two indices has a remarkable history; no big change between 1988 and 2005, and then a sudden giant jump in the copper index. Fluctuations between 350 and 500 points lasted three years, and then the index dropped by ~300 units back to the PPI level. Despite the early start in 2005 the growth seems to be oil independent, the most recent fall looks to be driven by oil price and the overall economic slowdown. In July and August 2009, one can observe a sustainable increase in the cooper index likely associated with the rise in oil price. In the long-run, oil price should decline to the level of ~$25 in 2016. Therefore, copper price will likely not be growing to its peak in April 2008 (491.7), but will likely return to heights around 350. (Our model based on the presence of sustainable trends in the difference between the PPI and individual PPI is not applicable to copper ores.)

Figure 1. Evolution of the price index of copper ores and the PPI.

The producer price index for grains presents another difficult case. Figure 2 depicts the PPI and the index, and their difference between 1960 and 2009. There is no sustainable trend in the difference. Between 1974 and 2005, the difference demonstrated an overall growth with several spikes, the strongest one in 1996. The presence of a long-term positive trend in the difference is completely due to the growth in the PPI because the index of grains fluctuates around a constant level just slightly above 100 points. Lately, the grains index suffered the biggest rise and fall in absolute terms. The main increase started earlier in 2007 and stretched into 2008, with the peak in June 2008. Volatility of the difference during the past two years was so high that it is difficult to predict the next move of the price index of grains at a several year horizon. Seemingly, it has been repeating the trajectory of the index for crude oil in 2008 and 2009. If it is the case, one can expect that the index for grains will continue to oscillate around the constant level of ~100.

It is instructive to compare two major spikes in the grains index in 1996 and 2008 relative to the PPI. In order to avoid comparing absolute values, which undergo secular growth, the evolution of the difference between the PPI and the price index of grains normalized to the PPI. Figure 3 presents the normalized curves. The left panel shows that the spike in the grains PPI in July 1996 is similar in relative terms to that observed in 2008. The right panel tests this hypothesis: the spikes are synchronized - for the black line is shifted forward by 142 months. From this comparison, it is likely that decline in the grains index relative to the PPI will extend into the 2010s.

Figure 2. Evolution of the price index of grains and the PPI.

Figure 3. Evolution of the difference between the PPI and the price index of grains normalized to the PPI. Left panel shows that the spike in the grains PPI in July 1996 is similar to that observed in 2009. Right panel tests this hypothesis – the spikes are synchronized (time shift by 142 months). One might expect a decline in the grains index relative to the PPI will be extended into the 2010s.

Conclusion

In the short-run, the index for copper will be growing at least till the end of 2009. The index for grains will continue its decline relative to the PPI. As a consequence, one can expect that the index for food will be also decreasing and this decline will stretch into the 2010s.

In the long run, the producer price index for copper and that of grains both demonstrate practically unpredictable behavior with unclear future. This observation only emphasizes the importance of sustainable trends observed for other commodities. In the US economy, as in many natural systems, there exist trend components, oscillating components, and random components.

References
1. Kitov, I., Kitov, O., (2008). Long-Term Linear Trends In Consumer Price Indices, Journal of Applied Economic Sciences, Spiru Haret University, Faculty of Financial Management and Accounting Craiova, vol. 3(2(4)_Summ), pp. 101-112.
2. Kitov, I., (2009). Apples and oranges: relative growth rate of consumer price indices, MPRA Paper 13587, University Library of Munich, Germany.
3. Kitov, I., Kitov, O., (2009). A fair price for motor fuel in the United States, MPRA Paper 15039, University Library of Munich, Germany,
4. Kitov, I., Kitov, O., (2009). Sustainable trends in producer price indices, Journal of Applied Research in Finance, v. 1, (in press)
5. Kitov, I., Kitov, O., (2009). PPI of durable and nondurable goods: 1985-2016, MPRA Paper 15874, University Library of Munich, Germany
6. Kitov, I., (2009). Predicting gold ores price, MPRA Paper 15873, University Library of Munich, Germany
7. Kitov, I., (2009). Predicting the price index for jewelry and jewelry products: 2009-2016, MPRA Paper 15875, University Library of Munich, Germany
8. Kitov, I., Kitov, O., (2009). Predicting share price of energy companies: June-September 2009, MPRA Paper 15863, University Library of Munich, Germany
9. Kitov, I., Kitov, O., (2009). Modelling selected S&P 500 share prices, MPRA Paper 15862, University Library of Munich, Germany

Predicting ConocoPhillips and ExxonMobil stock price

Lately, I have published an article on the prediction of stock prices for COP and XOM - “Predicting ConocoPhillips and Exxon Mobil stock price”, Journal of Applied Research in Finance, v.2, 2009. (A draft version is available here.)

Abstract
Exxon Mobil and ConocoPhillips stock price has been predicted using the difference between core and headline CPI in the United States. Linear trends in the CPI difference allow accurate prediction of the prices at a five to ten-year horizon.
Key words: stock price, Exxon Mobil, ConocoPhillips, prediction, CPI
JEL classification: G1, E3

We continue modelling various stock prices and recently revisited XOM and COP. The general model can be rewritten in the following form:

sp(t)= A1S1(t+t1) + A2S2(t+t2) + A3t +A4

where sp(t) is the stock price at time t, A1 through A4 are empirical coefficients, S1 and S2 are components of headline CPI, t1 and t2 are time difference (negative or positive) between the change in the stock price and relevant changes in the CPI components. Term A3t is introduced to compensate linear trends observed in the difference between the components.

For ConocoPhillips and Exxon Mobil, more accurate empirical models are as follows:

Figure 1. Comparison of measured (open circles) and predicted (solid diamonds) stock prices of ConocoPhillips. The prediction is obtained from the following empirical relationship:

COP(t)= 3.41CF(t+2) - 7.17EC(t-5) + 7.22*(t-2000) + 145.76,

where CF(t+2) is the headline CPI less food lagged by one months behind COP(t), and EC(t-5) is the index for education and communication leading the COP(t) by five months. The explicit trend term 7.22*(t-2000) compensates the trend term in the difference between CF and EC. Standard deviation between the curves is $4.0 for the period between July 2003 and August 2009.

Figure 2. Comparison of measured (open circles) and predicted (solid diamonds) stock prices of ExxonMobil. The prediction is obtained from the following empirical relationship:

removed by author

Standard deviation between the curves is $3.27 for the period between July 2003 and August 2009.

These two models provide a good approximation of the price evolution and even predict the future price for XOM.

Crude oil at $100 in December: August update

In March 2009, we presented a prediction of crude petroleum price for 2009. Briefly, our analysis has shown that oil will overcome $100 per barrel before the end of 2009. As promised, we evaluate this prediction every month, when new readings of producer price index (PPI) with all its components become available. In this article, we report the results for August 2009.

The period between January 2008 and likely the end of 2010 is characterized by an elevated volatility in oil price, but the evolution of the price is not random. Moreover, even after the start of crisis in 2008, the price has been following a predetermined trajectory, as it has been demonstrating since 1980.

In August, the PPI reached the level of 175.1 from 172.7 in July, and the producer price index of crude petroleum (domestic production) increased to 190 after 158.9 in July. Our assumption on the average monthly increment for the crude petroleum index was +20, and for the PPI +1. So, the increase in August was larger than predicted. However, this increase just compensated the fall in the difference observed in July relative to June.

Figure 1 presents the new readings. Overall, the evolution of the difference between the PPI and the index for crude petroleum follows the predetermined path (compare the updated curve to that drawn in June) – from its peak in February 2009 to the bottom of a through, which will likely be reached by December 2009. This is a natural path for a pendulum, as discussed in the previous articles [1], [2]. Hence, there is not sign that the oil price significantly deviates from the predicted trajectory. We expect the price to hit the new (red) trend line in September 2009. This is the level of $73-77 per barrel.

Figure 2 depicts the evolution of crude oil price. Values for the period between September and December 2009 are shown by solid red circles. According to the prediction, the price should break the $100 level before the end of 2009. The next update is expected in October or November 2009.

Figure 1. Evolution of the difference between the PPI and the index for crude petroleum (domestic production). Solid circles – the readings between March and August 2009, which were anticipated in February 2009. Open circles – the predicted difference between September and December 2009. Upper panel – figure from June. Lower panel – August update.

Figure 2. The evolution of crude oil price. Red circles – oil price predicted for the period between July and December 2009. According to the prediction, the price should break the $100 level before the end of 2009.

How big are bank problems in the USA?

Bloomberg cites Joseph Stiglitz, who has evaluated bank problems as bigger than pre-Lehman. This is a questionable statement because it is based on a qualitative evaluation. Our stock price model allows to evaluate the difference between 2008 and 2009 in a quantitative format - adjusted share price.

First, we show some examples of poor banks which have approached the level of bankraptcy:

1. Citigroup (C) reached the bottom in the beginning of 2009. Was bailed out. On an upward trend right now - no problems in the near future, as the model says. I consider the possibility to invest right now.
(N.B. here and below we do not provide actual empirical relationships behind the predicted curves because they are confidential.)

2. Colonial Bank (CNB) reached the bottom in March 2009. Is a part of BBT now. Why isn't it bailed out?

3. CIT Group Inc. Must fail in April, but was bailed out.


4. E*TRADE financial corporation (ETFC) definitely has problems in 2009. Our model is highly unceratain because of the uncertainty in underlying data. ETFC will likely have a problem by the end of 2009, but then will recover quickly.


5. SLM Corp. (SLM) seems to have hard time in the near future. This is the only problem bank we have found among those in S&P 500. Will watch its evolution




Several positive examples of large importance:

6. Fifth Third Bancorp (FITB) approached the zero line in the beginning of 2009. has been successfully recovering since. Demonstrates sustainable growth, but still its share price is at the level of October 2008. I wonder that Stiglitz confused the down- and upgoing branches. It is worth noting that S&P 500 banks are chiefly on rise with large positive trends.



7. Bank of America dropped very low but recovered fast. The model predicts relatively quick growth.


8. Goldman Sachs has only slight problems compared to those associated with CIT and CNB. Currently is closing its 2007 level. No problems are foreseen.


9. JPMorgan Chase is very similar to GS. Stays good for investment.


Conclusion.
Stiglitz and Co. look to be mistaken about problems in 2009. It might be another decline in the second part of 2010, however.

Does economics need a scientific revolution?

David Altig at macroblog has joined the fierce discussion of the problems in theoretical economics related to the complete failure in prediction of the current crisis. The economic profession is very reluctant to recognize (not admit) the inconsistency of the mainstream ideas and tools.

Briefly, our approach has been formulated in the article "Does economics need a scientific revolution?" as a reaction to the article by J.-P. Bouchaud "Economics need a scientific revolution" in Nature.

Our research, as a whole, is a quantitative alternative to the mainstream economics. This blog highlights relevant results.

S&P 500 in August 2009

I have found a short paper citing our article on the prediction of S&P 500 returns as an example of " how statistics can be manipulated to show relationships where none exist". I have to admit that these people did not give any effort to read our article before writing own. As a consequence, they misinterpreted the essence and details of our study.

For a quantitative prediction, the best way to proceed is to continue presenting current results, as we have been doing from March 2009. In August 2009, S&P 500 jumped to 1020 from 987 in July 2009, i.e. by 33 points. As in our previous posts, we depict an updated graph for observed and predicted S&P 500 - Figure 1. All in all, our predictions from March 2009 are accurate to the extent of the number of 9-year-olds is uncertain.

Figure 1. Observed (red) and predicted (black) S&P 500. The leg from March 2009 (bottom point of the curve) was also predicted as a straigt line continuing the black portion. Considering the 6-month horizon of the prediction and the time when it was done (near the bottom of S&P 500), so far the prediction is accurate, but likely we have to calibrate it a bit down because the change in the number of 9-year-olds is overestimated for 2008 through 2010. In any case, we expect another nine months of growth. And the level of 1200 to 1300 by the end of 2009.

Figure 2. Observed and predicted 12-month returns of S&P 500. The model linking S&P 500 to the number of 9-year-olds and real GDP is described in our article and previous posts.

We will continue comparing our prediction and actual S&P 500 and presenting update figures.

As to the paper mentioned in the beginning, these people will never be convinced that they do not understand how the economy and financial market work. It is against their interests.