Things Are Exactly That Bad... and that's good!

December 11, 2009 Edition, Volume III

Inside Signature Update

- The Market – The Yield Curve: Revisited
- The Economy –Things are exactly that Bad… and that’s good!
- The Takeaway – We told you not to get caught


THE MARKET – The Yield Curve: Revisited

Even though Signature Update has discussed positive-sloping yield curves in the past, it seems appropriate to mention the shape of the current curve. Yield curves, the graphic representation of treasury yields for varying lengths of maturity, most often foretell the general direction of the stock market. A positive slope reflects higher treasury yields for longer maturities – which is exactly what one would expect – and has routinely been a precursor to prolonged equity market gains. A flat or negatively sloped curve, like the one we saw in the later part of 2007 and 2008, is indicative of a disquieted credit market and most often leads to lower stock market values.

Sometimes we misinterpret these forecasting tools and suppose they mean something other than what they’ve so accurately represented for many years. As investors, we often want to look only at the positive side of the markets and may mistake an otherwise obvious sign. This is often the case when a negatively sloping curve is suggestive of declining stock market values. As economists, we tend to be more pragmatic and are most interested in the changing economic landscape; regardless of the direction of change.

The current yield curve not only has a positive slope, but is steeper than at any time since the early 1980’s. It suggests an upward trending equities market for an extended period of time and is difficult to ignore. Recent economic updates reflecting increased consumer spending, manufacturing activity, and improving labor patterns support continued market improvement and paint a compelling picture for a profitable 2010.

One of the more positive signs we’ve seen has been the recent improvement in the US dollar, aligned with stock market gains. Divergent dollar/equities movement had become a concerning trend, and while we may continue to see more uncorrelated dollar/equities moves, it appears the trend is breaking none too soon.

The weak dollar, though good for export activity and ‘gold bugs’ has elicited concern the world over. Even without outward support from the Federal Reserve and US Treasury, the dollar has gained ground in recent weeks and the upward sloping yield curve, also an indicator of future interest rates, supports meaningful currency exchange gains and hope for moderated inflation pressures. Both offer welcome relief to consumers and investors, excepting those gold investors who may have fallen prey to opportunistic pressures in the precious metals and commodities markets.



THE ECONOMY – Things are exactly that Bad… and that’s good!

A reader recently sent me an internet link to an interesting graphic representing the state-by-state change in unemployment from January 2007 to October 2009 (see weblink below). The image the graphic created was one of alarm, and the reader, as might be expected, sought reassurance while asking ‘could things really be this bad?’ The chart steadily became more concerning as it cycled through each month and paints a picture most would find alarming… unless, of course, the observer understood the history of employment cycles.

My answer to the reader’s question: ‘Yes, they’re exactly that bad’. I then went on to remind him that a similar graphic for the mid 1970’s and early 1980’s looked yet worse; as would one for the recessions of the 1830’s, 1850’s, 1860’s, 1880’s, 1890’s, 1907, and 1920’s. Likewise, a graphic for the depressions of the 1870’s, 1890’s and 1930’s would make the current graph look insignificant.

The point is that labor economies cycle through patterns of growth followed by recessive periods. Until the 1930’s these recessive periods were far more frequent than they have been in the last sixty plus years, and worse, they tended to last longer and drive deeper. The accumulated economic impact stifled growth and development throughout the country as individuals and businesses constantly strove to recover from last year’s recession, while endeavoring to prepare for what might come next. Economic stability was an audacious hope at the time.

The implementation of federal and state banking, investment and securities regulations, in addition to the creation of the Federal Reserve and FDIC served to bring relative economic stability to the country and each have served us well. I’m not trying to sound like an apologist for the Federal Reserve, though I’m frequently supportive of various Fed policies, and I’m certainly not a fan of excessive regulation, but the necessity of a strong central bank and active regulatory environment is critical in even the freest of markets.

Which brings us to Friday’s passage of legislation by the US House of Representatives calling for the most significant increase in the regulation of US banks and other corporations since the Great Depression. The bill passed without Republican support and absent the vote of 27 Democrats; passage in the Senate seems unlikely.

The Obama administration issued a statement in support of the legislation; "The crisis from which we are still recovering was born not only of failure on Wall Street, but also in Washington. We have a responsibility to learn from it, and to put in place reforms that will promote sound investment, encourage real competition and innovation, and prevent such a crisis from ever happening again." Good words, but with unfortunate affect.

This bill offers another layer of inefficient bureaucracy on top of an already highly regulated industry. Certainly, there are new financial products, such as Credit Default Swaps (CDS) and Collateralized Debt Obligations (CDO), that merit regulatory supervision, but too much regulation can be just as damaging as too little. The current populist call for regulating everything from executive salaries to a family’s carbon footprint (not part of the bill in reference) is overreaching and ultimately can produce more harm than good. Thankfully, the Senate version of the bill offers a more reasoned approach and with hope, audacious though it may be, by the time the legislation makes its way through the congressional reconciliation process it may offer more productive solutions than the current House version.

http://cohort11.americanobserver.net/latoyaegwuekwe/multimediafinal.html




THE TAKEAWAY – We told you not to get caught

Expect higher interest rates to filter through the economy even before the Federal Reserve moves to raise the Fed Funds and other target rates. Though the increased cost of borrowing may be disheartening to some, they will help bankers choose to lend more freely and will help stave off potential inflation pressures.

Look to the Senate to lead the way towards more reasoned regulatory pressures, but be willing to speak out to your House and Senate representatives; it’s your money they’re spending and your nation they seek to govern.

4th Quarter GDP forecasts are likely to be revised upwards in coming weeks as the economy appears to be making a more robust recovery than previously expected. Though it will take many more months for the improvement to provide meaningful relief for the labor markets, the strengthening dollar and moderating commodities markets are welcome signs. Oh… and stock market gains don’t hurt much!




Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC