February 19, 2010 Edition, Volume IV
Inside Signature Update
- The Market – Interest Rate Excitement from the Fed
- The Economy – Inflation’s Simply Not on the Horizon
THE MARKET – Interest Rate Excitement from the Fed
The DOW closed slightly higher in moderate trading on Friday following the Federal Reserve’s announcement that it would increase the Fed Discount Rate by .25%. Within minutes of the Thursday afternoon Fed statement, many Wall Street traders, analysts and media representatives began to foretell of higher interest rates and lower stock markets. And indeed, the markets opened sharply lower Friday morning as the DOW futures suggested a decline of 70 points, but by noon most market indexes were up and largely remained that way for the remainder of the trading session.
Conventional wisdom suggests that rate increases spell trouble for the markets, so why not today? And how is it that early forecasts for lower equity values turned into a nine point gain on the DOW? Well, as it turns out, conventional wisdom isn’t all that conventional or wise; and most people don’t understand the relationship between the Federal Reserve and interest rates well enough to see how a change in the Fed’s discount rate impacts the market. Thank goodness for level headed economists.
The Fed Discount rate is not a market interest rate. Rather, it’s the rate the Fed charges banks wishing to borrow directly from the Federal Reserve; the lender of last resort. The discount rate had been set at .5% and member-bank borrowing was holding at just over $15 billion; compared to nearly $13 trillion of liquidity being held in domestic banking and capital market accounts. The .25% increase amounts to a very small drop in a very large bucket, and by the time traders and investors were able to digest the news and get past some of the initial excitement, the realization set in that the event was neither unexpected nor troublesome; quite the opposite.
Fed Chairman Bernanke has stated for some time that US monetary policy will need to tighten as the economy improves. Though tightening may manifest itself in many ways, the most common result is higher interest rates; whether through the Fed’s purchase (or sale) of bonds, increased reserve requirements imposed on member banks, or federal fiat. Even though the Fed’s decision to increase the discount rate is one of the least impactful on market interest rates, it’s evidence that higher rates will be in our future; just not right now.
Higher rates equate to a stronger dollar; as evidenced in declines in the price of oil and gold in early trading. But by the end of the session, both commodities had rallied along with the DOW. The bond market experienced similar activity.
So if the Fed’s action doesn’t necessarily signal a near-term increase in market rates, then what does it represent? Simply that Bernanke and the Fed Board of Governors see an end to the risk trade, an improvement in liquidity of member banks, and an overall strengthening in the US and global economies. Following the PIGS (Portugal, Italy, Greece and Spain) sovereign debt concerns of recent weeks, that’s excellent news. The Fed’s monetary policy staff, which includes some of the smartest economic analysts any of us will ever encounter, doesn’t make such decisions casually; especially in an election year with unemployment near 10%.
Market interest rate increases will most likely begin to appear late in 2010 and the Federal Reserve will probably put off increases in the Fed Funds Rate until after the mid-term election; possibly as late as early 2011. The employment and real estate markets both need the added support of low rates and a not-too-strong US dollar. In the mean time, expect the Fed to continue to moderate its support of the mortgage market and member banks; fewer of which are in need of Fed capital.
THE ECONOMY - Inflation’s Simply Not on the Horizon
One of the most consistent concerns expressed during the last year has been over possible inflation brought on by the substantial increase in federal spending and increases in the M1 and M2 money supplies. Gold Bugs have used the concern as a means of pushing the commodity’s price higher; political conservatives have used it as a stick with which to beat the Obama administration, though with little merit; and some of those on fixed incomes have begun to scale back their lifestyles to adjust to pending price increases. But there’s simply no empirical evidence to support the current fears. Which is either a Good News/Bad News tale, or possibly Bad News/Bad News; allow me to explain.
The CPI (consumer price index) data released this morning by the US Department of Labor’s Bureau of Labor Statistics reflected a .1% decrease in core price levels for the first time in twenty-seven years. When compared to similar data from the past 12 months we see that core prices have slowed their rate of increase from monthly rates of less than .3% to the recent .1% decline. The movement has not coincidentally followed the decline in US employment rates; which relationship will become important as we move on.
Core price levels don’t include energy and food items and shouldn’t be viewed in isolation. But even when the CPI is expanded to include all items, the annual rate of increase is barely 2.6%; not exactly representative of hyper inflation.
Persistent inflation can only occur when personal income levels increase sufficiently to put enough additional buying power into the hands of consumers and encourage them to seek after greater quantities of goods and services; pushing prices higher. Even though personal income levels increased slightly in 2009, and are likely to do so again in 2010, the increases aren’t enough to significantly raise prices. As long as we’re dealing with high levels of unemployment and a limited wage/price relation, broad-based inflation can’t reasonably gain hold of the economy.
Most policy makers, notably labor economists, have come to realize that persistent inflation has become meaningfully more difficult to experience than in decades past. Many of us recall the inflation and stagflation periods on the 1970’s and 1980’s, but don’t realize how much of that was a product of the strength of labor unions and collective bargaining contracts. These cooperatives have substantially less power today than they did during the latter half of the 20th century; consequently, wage increases for the foreseeable future will remain modest.
Many of the personal income increases hourly wage earners experienced up through the 1980’s were the result of labor productivity gains; as such, employers were motivated to pass some of the gains on to workers. But since the early 1990’s, most productivity increases have been brought about by technology gains requiring large capital investment by business owners and shareholders; not by improvements in labor. In many cases these gains have decreased the need for skilled workers and rather than bringing about increased incomes for wage earners, they’ve been more likely to provide returns for investors, business owners and corporate executives; otherwise these groups would have limited incentive to innovate and invest.
So what’s the Good News/Bad News tale? The much feared inflation scenario simply isn’t on the horizon; due in large part to employment levels that are likely to be persistently lower and personal income increases for hourly-wage earners that are likely to be nominal. And the Bad News/Bad News possibility? Across-the-board tax increases are nearly inevitable, and are likely to put additional pressure on household discretionary income; which could serve to slow price increases even further and make it that much more difficult for a return to a robust employment market.
There are solutions to all of this, of course, and they include improvements in education, technology and the capital markets. And we’ll discuss these further over the next several issues of Signature Update.
Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC
Friday, February 19, 2010
Thursday, February 18, 2010
Opportunities in Markets and Inventory Levels
February 18, 2010 Edition, Volume IV
Inside Signature Update
- The Market – Corrections and Opportunties
- The Economy – 2010 GDP Prospects and Manufacturing Opportunities
- The Takeaway – Likely to See Equity Levels Rise & Commodities Weaken
THE MARKET – Corrections and Opportunities
The recent ups and downs in the US stock markets may have presented cause for concern for traders dependent on short-term technical market trends, but has spelled opportunity for investors seeking long-term gains. The DOW, now off of its 52-week high by over 400 points (3.8%) following Wednesday’s close, is nearly 450 points above its early February low.
The market volatility of recent weeks, though in part attributable to political events in the US and abroad, and the relative strengthening of the US dollar, has also represented what many consider to be a healthy correction. The early-February low near 9,900 on the DOW represented a correction of 8% against the 52-week high of 10,767. Most forecasters were looking for a correction of 7-10%; the 9,900 support level we’ve climbed up from appears to have calmed most concerns and opened a clear path for newer highs.
Why markets appear to need corrections on an interim basis before climbing to new heights is likely more of an emotional safety check for traders than the result of any pragmatic or fundamental cause. Both traders and investors take comfort, and often find confidence, in a market as they understand that a brief cooling-off period often results in short-term declines followed by longer-term extended gains. The current market climate is indicative of this behavior and rather than to be feared, ought to
be seen as an opportunity to purchase attractive assets at lower levels.
Finally, at the risk of sounding like a broken record, the US Treasury Yield Curve continues to be sharply positive and represents one of the strongest indicators available of future market gains. Months ago, when the market and economy were both offering encouraging signs, I suggested that this was just starting. Now, almost six months and 1,000 points of improvement on the DOW later, I’ll repeat the expectation … this is just starting.
THE ECONOMY – 2010 GDP Prospects and Manufacturing Opportunities
GDP (gross domestic product) revisions for the full year and 4th quarter of 2009 will be out soon, and like those of recent quarters, are likely to be revised slightly upwards. Contrary to what many may have you believe, the US economy is in full recovery mode. That’s not to say that everything is positive or even to suggest that all sectors of the economy are on solid footings; but it does represent that the financial, manufacturing, retail, real estate, agricultural, financial and labor markets are improving.
The most troublesome sectors of the economy continue to be housing (real estate) and jobs (labor). Though slightly improved over prior months and quarters, they remain below important levels and continue to cause fiscal and emotional pain for far too many American households.
On a decidedly brighter note, most other economic indicators have not only improved, but have done so for enough back-to-back periods to represent a firm direction and trend rather than possible anomaly. In recent economic reports, durable goods orders and shipments rose .3% and 2.9% respectively, personal and discretionary incomes each increased by .4%; retail sales increased 12.9%; employment improved by .5% (though still high at 9.7%); and inventories declined by more than $33 billion dollars.
Perhaps the most important figure in that list is the inventory figure. Throughout the recession, inventory levels declined as retailers and wholesalers sought to limit their exposure to declining retail sales and reduce expenses. Virtually every calendar quarter brought lower inventory levels - hand-in-hand with the decrease in manufacturing and distribution jobs. Surprisingly, declining retail sales figures never resulted in increased inventories and consumers have continued to buy more than was being manufactured.
With consumer spending on the rise, the pressure to build inventory levels is mounting – this accounts for some of the recent employment improvement. Lower unemployment, however modest, translates into higher personal incomes and increased consumer spending, which in turn puts yet more pressure on inventories. It becomes one of those positive developments we’ve needed to see for many months.
Some will argue that much of US retail consumption comes from foreign manufacturing, and the production increases that will rebuild inventories will have a positive impact elsewhere but not at home. Though seemingly rational, that manner of thinking is incomplete and leads to inaccurate conclusions. Though US consumers purchase many hundreds of billions of dollars in foreign-made goods each year, increasing retail sales and inventory builds offer sufficient US manufacturing opportunities to reverse employment trends and add the jobs needed to return the labor market to full employment. Additionally, the US market is nearly as dependent on foreign consumption as it is domestic. As foreign manufacturers increase output to meet domestic needs, their employees purchase US-made goods and services along side of those from other countries. In fact, the weaker US dollar has increased the proportion of US goods purchased by foreign markets - enough so that our corporations and investment markets have benefited from improved export sales and decreased trade imbalances.
Some have wrung their hands over tightening monetary policy in China; again, what seems rational is incorrect. China pegs the yuan closely to the dollar and what’s good for the Chinese currency is typically good for the dollar. Were the US political climate strong enough to allow for tightening at the Fed, the dollar would improve; and in time, the US economy would be stronger for it.
We now stand to gain nearly as much from foreign manufacturing of goods to be consumed in the US as we do manufacturing those goods domestically. Though our economy remains subject to uncertainty in some sectors, we are stronger, leaner and more secure than we’ve been in many months. And that’s worth a 2010 GDP forecast of 5% - 5 ½%.
THE TAKEAWAY – Likely to See Equity Levels Rise and Commodities Weaken
- Take advantage of market weakness to strengthen equity positions. Though we may see lower levels sometime this year, we’re more likely to see equity indexes rise and commodities weaken.
- The political climate of a mid-term election year isn’t likely to encourage the Federal Reserve to tighten monetary policy. The dollar, stronger relative to many other currencies in the wake of the PIGS (Portugal, Italy, Greece and Spain) sovereign debt concerns, isn’t likely to fall prey to domestic inflation pressures.
- Personal and discretionary income gains of .4% may seem insignificant, but when compared to CPI (consumer price index) increases of less than .1% for the same period it equates to an increase in buying power at the household level.
Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC
Inside Signature Update
- The Market – Corrections and Opportunties
- The Economy – 2010 GDP Prospects and Manufacturing Opportunities
- The Takeaway – Likely to See Equity Levels Rise & Commodities Weaken
THE MARKET – Corrections and Opportunities
The recent ups and downs in the US stock markets may have presented cause for concern for traders dependent on short-term technical market trends, but has spelled opportunity for investors seeking long-term gains. The DOW, now off of its 52-week high by over 400 points (3.8%) following Wednesday’s close, is nearly 450 points above its early February low.
The market volatility of recent weeks, though in part attributable to political events in the US and abroad, and the relative strengthening of the US dollar, has also represented what many consider to be a healthy correction. The early-February low near 9,900 on the DOW represented a correction of 8% against the 52-week high of 10,767. Most forecasters were looking for a correction of 7-10%; the 9,900 support level we’ve climbed up from appears to have calmed most concerns and opened a clear path for newer highs.
Why markets appear to need corrections on an interim basis before climbing to new heights is likely more of an emotional safety check for traders than the result of any pragmatic or fundamental cause. Both traders and investors take comfort, and often find confidence, in a market as they understand that a brief cooling-off period often results in short-term declines followed by longer-term extended gains. The current market climate is indicative of this behavior and rather than to be feared, ought to
be seen as an opportunity to purchase attractive assets at lower levels.Finally, at the risk of sounding like a broken record, the US Treasury Yield Curve continues to be sharply positive and represents one of the strongest indicators available of future market gains. Months ago, when the market and economy were both offering encouraging signs, I suggested that this was just starting. Now, almost six months and 1,000 points of improvement on the DOW later, I’ll repeat the expectation … this is just starting.
THE ECONOMY – 2010 GDP Prospects and Manufacturing Opportunities
GDP (gross domestic product) revisions for the full year and 4th quarter of 2009 will be out soon, and like those of recent quarters, are likely to be revised slightly upwards. Contrary to what many may have you believe, the US economy is in full recovery mode. That’s not to say that everything is positive or even to suggest that all sectors of the economy are on solid footings; but it does represent that the financial, manufacturing, retail, real estate, agricultural, financial and labor markets are improving.
The most troublesome sectors of the economy continue to be housing (real estate) and jobs (labor). Though slightly improved over prior months and quarters, they remain below important levels and continue to cause fiscal and emotional pain for far too many American households.
On a decidedly brighter note, most other economic indicators have not only improved, but have done so for enough back-to-back periods to represent a firm direction and trend rather than possible anomaly. In recent economic reports, durable goods orders and shipments rose .3% and 2.9% respectively, personal and discretionary incomes each increased by .4%; retail sales increased 12.9%; employment improved by .5% (though still high at 9.7%); and inventories declined by more than $33 billion dollars.
Perhaps the most important figure in that list is the inventory figure. Throughout the recession, inventory levels declined as retailers and wholesalers sought to limit their exposure to declining retail sales and reduce expenses. Virtually every calendar quarter brought lower inventory levels - hand-in-hand with the decrease in manufacturing and distribution jobs. Surprisingly, declining retail sales figures never resulted in increased inventories and consumers have continued to buy more than was being manufactured.
With consumer spending on the rise, the pressure to build inventory levels is mounting – this accounts for some of the recent employment improvement. Lower unemployment, however modest, translates into higher personal incomes and increased consumer spending, which in turn puts yet more pressure on inventories. It becomes one of those positive developments we’ve needed to see for many months.
Some will argue that much of US retail consumption comes from foreign manufacturing, and the production increases that will rebuild inventories will have a positive impact elsewhere but not at home. Though seemingly rational, that manner of thinking is incomplete and leads to inaccurate conclusions. Though US consumers purchase many hundreds of billions of dollars in foreign-made goods each year, increasing retail sales and inventory builds offer sufficient US manufacturing opportunities to reverse employment trends and add the jobs needed to return the labor market to full employment. Additionally, the US market is nearly as dependent on foreign consumption as it is domestic. As foreign manufacturers increase output to meet domestic needs, their employees purchase US-made goods and services along side of those from other countries. In fact, the weaker US dollar has increased the proportion of US goods purchased by foreign markets - enough so that our corporations and investment markets have benefited from improved export sales and decreased trade imbalances.
Some have wrung their hands over tightening monetary policy in China; again, what seems rational is incorrect. China pegs the yuan closely to the dollar and what’s good for the Chinese currency is typically good for the dollar. Were the US political climate strong enough to allow for tightening at the Fed, the dollar would improve; and in time, the US economy would be stronger for it.
We now stand to gain nearly as much from foreign manufacturing of goods to be consumed in the US as we do manufacturing those goods domestically. Though our economy remains subject to uncertainty in some sectors, we are stronger, leaner and more secure than we’ve been in many months. And that’s worth a 2010 GDP forecast of 5% - 5 ½%.
THE TAKEAWAY – Likely to See Equity Levels Rise and Commodities Weaken
- Take advantage of market weakness to strengthen equity positions. Though we may see lower levels sometime this year, we’re more likely to see equity indexes rise and commodities weaken.
- The political climate of a mid-term election year isn’t likely to encourage the Federal Reserve to tighten monetary policy. The dollar, stronger relative to many other currencies in the wake of the PIGS (Portugal, Italy, Greece and Spain) sovereign debt concerns, isn’t likely to fall prey to domestic inflation pressures.
- Personal and discretionary income gains of .4% may seem insignificant, but when compared to CPI (consumer price index) increases of less than .1% for the same period it equates to an increase in buying power at the household level.
Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC
Friday, February 5, 2010
Can the US Economy Grow Without Employment Gains?
February 5, 2010 Edition, Volume IV
Inside Signature Update
- The Market – Better Dollar, Labor & Earnings: why are stocks lower?
- The Economy – Can the US Economy Grow without Employment Gains?
- The Takeaway – Relax and Enjoy the Super Bowl
THE MARKET – Better Dollar, Labor & Earnings: why are stocks lower?
With the strengthening US dollar, improving unemployment and stronger corporate earnings, why has the US stock market had such a difficult time in recent weeks? The answer is more complex than most care to consider, but can be boiled down to a few basic parts: a possibly overdue market correction, the strengthening of the US dollar against foreign currencies, anti-business rhetoric, recovery fears, and basic uncertainty.
To begin with, the market has enjoyed an impressive rally from its early 2009 low of 6,500 on the DOW. Even compared with today’s close of just over 10,000 that’s a 54% rise in just over 10 months. Most market analysts would expect a market correction of up to 10% to follow this sort of increase before the market would be poised to rise to yet higher levels. For traders (short-term) this represents an opportunity to sell profitable positions and buy back into the market at lower levels; the problem is knowing when and at what levels. For investors (longer-term) there’s less cause for concern. At worst it should be an opportunity to adjust allocation parameters; again the question is when and at what levels. Most investors wisely choose to ride through this type of correction; most traders increase their intake of antacids or alcohol.
The real strengthening of the US dollar has been the byproduct of improved GDP reports (5.7% for 4th Quarter 2009), increased productivity and earnings for many US corporations; as well as stabilizing, if not outright improvement, in the US labor market. At the same time that the dollar has enjoyed “real” improvement, it has also experienced “relative” improvement against foreign currencies. For example: the Euro is having a difficult time in the wake of concerns over default of Greece’s and Spain’s sovereign debt obligations. Right now it looks as though these countries will either default on their debt or be bailed out by the EU, either way the Euro will suffer and the concern has resulted in a flight to safety into the US dollar. So much for sensationalized reports of the dollar’s demise as an international currency.
Historically, when the dollar has strengthened the US equities market has enjoyed extended gains. But in more recent years the two have been counter-correlated; that is, they’ve tended to move in opposite directions. It’s difficult to tell how long this phenomenon will last and even more so to explain why it is present at all, but for right now, a stronger dollar results in lower US stock prices. It also yields lower commodities (oil, gold, etc) values.
The anti-business rhetoric coming out of Washington has many investors and decision makers concerned. It’s not just that the President and his advisors seem determined to stall economic gains by putting pressure on profitable employers (see Not a Good Time for Anti-Business Rhetoric), but the tone breeds uncertainty; the markets disdain uncertainty. If you’re on Wall Street, you’re likely to prefer bad news over uncertainty and confusion; at least then you know what you’re dealing with.
In addition to Obama administration proposals to limit banks’ ability to create profits, which also limits their ability to lend, we’re now hearing about plans to tax the foreign earnings of US corporations as those earnings are realized in the US. While the prospects of new tax revenues may be appealing to legislators, we have to realize that the more likely result will be those profitable corporations keeping foreign earnings in their countries of origin; i.e. outside of the US. The result: new jobs created outside of the US, R&D spending outside of the US and corporate innovation outside of the US. This isn’t exactly what the US labor market needs right now.
All of this has brought renewed concerns over the strength and sustainability of the ongoing economic recovery. No longer do we hear questions about whether the recovery is real, rather, we now hear comments regarding how sustainable it might be. And it’s a good question. (For a more complete discussion take a look at the following THE ECONOMY section of this article)
On the positive side; GDP is rising, unemployment is moderating and may even be in the early stage of a reversal, and corporate profits are returning. Corporate revenues and profits are well ahead of 2009 levels and as of this morning, there were 39 major US corporations that had either reinstated or increased dividends to shareholders. Retail sales have been slowly improving and the US consumer has decreased short-term debt at the highest rate in decades. The Treasury yield curve (a relatively consistent indicator of a rising stock market) has extended its positively sloping trend and the US markets are up dramatically.
On the negative side; US auto sales are still lower than optimal, real estate values continue to be depressed in most markets, prolonged unemployment is ravaging otherwise fiscally healthy households, capital markets (lending) have yet to return to healthy levels, and deflation is still a real possibility at the same time that inflation concerns continue to capture media attention. Added to all of this to the fact that Washington insiders can’t seem to coalesce around a clear plan for growth and prosperity, and there’s little doubt as to why the markets are still more than a little jittery.
So why are the markets experiencing the sort of volatility reflected in today’s positive opening, sharp declines through the middle of the afternoon, and then surprising rebound for a profitable close? Maybe it’s just because it’s Friday and a major storm is bearing down on the east coast and maybe there’s a lot more to it than you’re likely to hear on the nightly news.
THE ECONOMY - Can the US Economy Grow without Employment Gains?
This morning’s release of the latest employment figures showed a surprising, though small improvement: unemployment is down to 9.7% from 10% and manufacturing jobs increased by more than 11,000. That may not sound like much, but this has all taken place without the expected build up in US inventories. When manufacturers are finally able to obtain the capital needed to build inventories back to reasonable levels, manufacturing employment at home and abroad will reflect robust improvement. But what if the confidence needed to rebuild inventories doesn’t materialize? What if the concerns arising from the current administration’s tone and legislative landscape continue to stifle potential employment gains? Then today’s sorry employment levels may become the new norm, even if only temporarily.
The real question becomes, can the US economy experience sustained growth without employment gains? The unfortunate answer is yes, but. Gains occur when revenues rise and/or productivity increases. Historically, productivity gains have directly and proportionately benefited workers, but that was when the productivity gains were more a product of improving labor efficiency. The productivity gains we’ve seen in recent years have been more a byproduct of technology improvement rather than through labor. When improving profits come about due to investment in technology rather than increased labor productivity, then little of the benefit is passed to the worker. The major part, if not all of it, is passed to investors (shareholders and/or capital market makers) who made available the capital needed to invest in the technology.
If shareholders and investors were evenly distributed across the spectrum of US households, then the benefit would likewise extend through all income classes, but that’s not our reality. Even though more households own stocks through 401(k)’s, IRA’s ESOP’s, and trading accounts than at any time in history, the bulk of equity ownership is still held by the highest income earners and the wealthiest of Americans. Additionally, the substantial capital investment needed to support corporate growth is largely made available through hedge funds, institutional investors, and venture capital firms – not exactly those living on Main Street, USA.
What this amounts to is that while economic growth can extend through periods of higher unemployment, it may serve to exacerbate the already widening income gap and yield far more benefit to wealthier households than to those in more critical need of additional resources. Many nations across the globe have lived this way for extended periods of time, but in the end, there’s been a heavy price to pay.
THE TAKEAWAY – Relax and Enjoy the Super Bowl
- The recent volatility in the US stock markets, though arising from a complex set of variables, is more of healthy correction that at is a long-term concern. Investors may do well to relax and enjoy this weekend’s Super Bowl; traders may watch it as well, but are less likely to be able to remember the outcome on Monday morning.
- It’s time for Washington to wake up to what really makes an economy prosper: innovation, jobs and investment and step aside from growth inhibiting proposals, regardless of how well they may be received by the mass electorate.
- Interest rates aren’t likely to rise until unemployment shows meaningful improvement, and that’s not likely to be observable until well into 2010, perhaps as late as the 4th quarter.
Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC
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