No surprises from the Fed today. In a unanimous decision the FOMC decided to stay the course and push forward with its QE2 bond buying program. The Fed released the following statement:
For immediate release
Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
There are undoubtedly many readers who disagree with Fed policy and its assessment of the economy. That is fine, but whether or not one agrees with Fed policy one had better take it into consideration when making investment decisions. I once had a boss who believed that Fed policy was misguided and bet against it. He wasn’t my boss long afterward.
Expect no changes from the Fed this year and only modestly higher long-term rates. Home prices are likely to trend lower as foreclosures are consummated and foreclosed homes come onto the market.
My 56th article was recently published on Seeking Alpha. Many thanks to all who support my efforts. It is more than I get from my employer.
Wednesday, January 26, 2011
Monday, January 24, 2011
Investor Tool Box
The FOMC meets this week and the result of the meeting will be (drum roll please) nothing. Oh sure, maybe we will see marginally more positive language in its statement, but the Fed is likely to leave policy unchanged. The Fed’s refusal to acknowledge the strength of the economic recovery has many market participants perplexed.
If one is perplexed it is because one does not understand what troubles the Fed. Mr. Bernanke and his merry band are concerned that employment is not recovering quickly enough. Not only that, but the FOMC does not see a segment in the economy which is poised to create large numbers of good paying jobs. Unlike many economists and strategists, the Fed is looking beyond models which indicate that jobs “always” recover and that hiring is just around the corner.
Recent data indicates consumers are dipping into savings to fuel their resurgent spending habits. This is not because they have found religion and reformed from their debt-laden ways. It is because they lack both disposable income and access to credit. If jobs are not created somewhere in the economy to keep the drive going, consumer spending could wane once savings are depleted.
Alright, we all know my opinion of jobs and inflation. I believe they are both likely to grind higher (as they have been). However, one should be prepared if the economy and inflation catch tailwinds. As with any task, one needs the correct tools. The problem is that investors to do not always know what tool to use.
Some investors are like do-it-yourself home repairers in that instead of assembly all of the appropriate tools to complete a task they try to accomplish their task by using an all-in-one multi-tool. This is what some investors are doing with their portfolios at the current time. Instead of constructing a diverse fixed income portfolio featuring a variety of vehicles with staggered or laddered maturities, they purchase the latest and greatest adjustable-rate or floating-rate note.
Investors and some financial advisers have been sold a bill of goods that floating-rate securities protect one’s portfolio against rising “interest rates” or rising inflation and will always trade at or near par. This is not the case. Look at it from the issuer’s (borrower’s) perspective. If their cost of financing is going to rise just because some rate rises, why issue a floater when rates are low.
The answer lies in debt schedules. Borrowers, be the corporations, municipalities, etc. need to spread their maturities out over the course of time. What they try to do is to issue long-term debt with coupons which float off of short-term benchmarks. This explains why there has been a plethora of long-maturity (but callable) bonds with coupons which float off of short-term benchmarks, such as three-month LIBOR. However, when it becomes more likely that short-term rates will rise due to possible Fed policy shifts (all U.S. dollar short-term rates are influenced by the Fed Funds rate) bond issuers will offer fewer adjustable-rate vehicles and offer more fixed-rate securities.
Another possibility is that they will issue bonds which float off of the 5-year treasury because the middle portion of the yield curve tends to be the least volatile or they will simply offer spreads over benchmarks so tight that the underlying benchmark has to sky-rocket for investors to be rewarded. Of course, most of these bonds have call features. This enables issuers to leave the bond outstanding when the bond is providing a cheap source of financing, but permits issuers to call in the bond when it is to THEIR advantage.
Instead of searching for the magic tool which allegedly performs all tasks well, it is better to construct a laddered and diverse fixed income portfolio, if rates rise, the short-term bonds will mature and permit reinvestment at a higher rate. Also, a rising rate environment usually means an improving economy. This can cause the credit spreads on corporate bonds to narrow which can help offset higher treasury yields.
A laddered and diversified portfolio also protects against low or lower interest rates by locking in a portion of one’s capital at comparatively-high rates for an extended period of time. A portfolio is like a tool box, it should be stocked with a variety of tools which come in handy in a variety of situations.
The Wall Street Journal Credit Markets column puts forth yet another theory on why the yield curve is steep at the present time. The Journal opines that it is because the U.S could lose its AAA credit rating. It is much more likely that the curve is this steep because the Fed has promised to keep the Fed Funds rate near 000% for an extended period of time and that the fear of deflation is dissipating. If fears that the U.S. is close to losing its AAA credit rating (or that inflation was poised to explode) the yield of the 10-year note would not be inside 3.50%
Stay warm!!!
If one is perplexed it is because one does not understand what troubles the Fed. Mr. Bernanke and his merry band are concerned that employment is not recovering quickly enough. Not only that, but the FOMC does not see a segment in the economy which is poised to create large numbers of good paying jobs. Unlike many economists and strategists, the Fed is looking beyond models which indicate that jobs “always” recover and that hiring is just around the corner.
Recent data indicates consumers are dipping into savings to fuel their resurgent spending habits. This is not because they have found religion and reformed from their debt-laden ways. It is because they lack both disposable income and access to credit. If jobs are not created somewhere in the economy to keep the drive going, consumer spending could wane once savings are depleted.
Alright, we all know my opinion of jobs and inflation. I believe they are both likely to grind higher (as they have been). However, one should be prepared if the economy and inflation catch tailwinds. As with any task, one needs the correct tools. The problem is that investors to do not always know what tool to use.
Some investors are like do-it-yourself home repairers in that instead of assembly all of the appropriate tools to complete a task they try to accomplish their task by using an all-in-one multi-tool. This is what some investors are doing with their portfolios at the current time. Instead of constructing a diverse fixed income portfolio featuring a variety of vehicles with staggered or laddered maturities, they purchase the latest and greatest adjustable-rate or floating-rate note.
Investors and some financial advisers have been sold a bill of goods that floating-rate securities protect one’s portfolio against rising “interest rates” or rising inflation and will always trade at or near par. This is not the case. Look at it from the issuer’s (borrower’s) perspective. If their cost of financing is going to rise just because some rate rises, why issue a floater when rates are low.
The answer lies in debt schedules. Borrowers, be the corporations, municipalities, etc. need to spread their maturities out over the course of time. What they try to do is to issue long-term debt with coupons which float off of short-term benchmarks. This explains why there has been a plethora of long-maturity (but callable) bonds with coupons which float off of short-term benchmarks, such as three-month LIBOR. However, when it becomes more likely that short-term rates will rise due to possible Fed policy shifts (all U.S. dollar short-term rates are influenced by the Fed Funds rate) bond issuers will offer fewer adjustable-rate vehicles and offer more fixed-rate securities.
Another possibility is that they will issue bonds which float off of the 5-year treasury because the middle portion of the yield curve tends to be the least volatile or they will simply offer spreads over benchmarks so tight that the underlying benchmark has to sky-rocket for investors to be rewarded. Of course, most of these bonds have call features. This enables issuers to leave the bond outstanding when the bond is providing a cheap source of financing, but permits issuers to call in the bond when it is to THEIR advantage.
Instead of searching for the magic tool which allegedly performs all tasks well, it is better to construct a laddered and diverse fixed income portfolio, if rates rise, the short-term bonds will mature and permit reinvestment at a higher rate. Also, a rising rate environment usually means an improving economy. This can cause the credit spreads on corporate bonds to narrow which can help offset higher treasury yields.
A laddered and diversified portfolio also protects against low or lower interest rates by locking in a portion of one’s capital at comparatively-high rates for an extended period of time. A portfolio is like a tool box, it should be stocked with a variety of tools which come in handy in a variety of situations.
The Wall Street Journal Credit Markets column puts forth yet another theory on why the yield curve is steep at the present time. The Journal opines that it is because the U.S could lose its AAA credit rating. It is much more likely that the curve is this steep because the Fed has promised to keep the Fed Funds rate near 000% for an extended period of time and that the fear of deflation is dissipating. If fears that the U.S. is close to losing its AAA credit rating (or that inflation was poised to explode) the yield of the 10-year note would not be inside 3.50%
Stay warm!!!
Tuesday, January 18, 2011
The Love Us Overseas!
Making Sense
Remember all the talk of foreign investors abandoning the U.S. dollar, that there will be few buyers for U.S. debt? Fears have not come to fruition, at least not yet. TIC data (foreign investor purchases of U.S. securities) indicate that foreign investors were in hot and heavy last November.
November data indicate a net inflow of foreign investment into U.S. securities of $39.0 billion. This is up from a prior revised $15.1B (up from $7,5B). Remember how investors, especially foreign investors, where going to specifically avoid the long end of the curve due to inflation concerns due to widening U.S. deficits and inflationary Fed policy? Well it appears as though someone forgot to tell foreign investors. Last November, the net inflow of foreign capital into long-dated U.S. debt was $85.1B. This was more than double the street estimate of $40.0B and a prior revised $28.9B (up from $27.6B). Remember, QE2 was launched in November, Rather than deterring foreign buyers, they were encouraged (for both investment and currency exchange reasons) to invest in dollars.
Thus far Fed policy has not led to much-feared higher inflation. Although long-term interest rates rebounded dramatically from their lows, they have stabilized near current levels as trades put on ahead of QE2 were unwound. However, some experts believe that inflation in the U.S. may be just over the horizon and is cropping up overseas now.
Stanford professor, Ronald McKinnon writes in today’s Wall Street Journal that Fed policy is helping to cause overseas inflation and that it is only a matter of time before the inflation wave arrives on our shores. Mr. McKinnon writes:
“What do the years 1971, 2003 and 2010 have in common? In each year, low U.S. interest rates and the expectation of dollar depreciation led to massive "hot" money outflows from the U.S. and world-wide inflation. And in all three cases, foreign central banks intervened heavily to buy dollars to prevent their currencies from appreciating.”
“When central banks issue base money to buy dollars, domestic interest rates are forced down and domestic inflationary pressure is generated. Primary commodity prices go up quickly because speculators can easily bid for long positions in organized commodity futures markets when interest rates are low.”
However, what may be different this time is the ability or willingness of consumers to borrow and spend. During the last such time of extremely “easy” Fed policy consumers were able to borrow and spend, often irresponsibly. The inability or unwillingness of consumers to borrow and spend may hold down so-called core inflation. That could alleviate the inflationary pressures on commodities. Mr. McKinnon warns that a second round of stagflation could lie ahead. Whether or not a repeat of the 1970s is in the cards remains to be seen. It all depends on actions and reactions of policy makers and consumers. However, Mr. McKinnon delivers a good synopsis of Paul Volcker’s success in defeating stagflation and responses by foreign central bankers. He also delivers a good synopsis of the most recent economic bubble. He writes:
“The Greenspan-Bernanke interest rate shock of 2003-04, followed by a weakening dollar into the first half of 2008, created the bubble economy. Primary commodity prices began rising significantly in 2003-04, then flattened out before spiking in 2007 into the first half of 2008.”
“But the biggest bubble was in real estate, both commercial and residential. With low mortgage rates and no restraining regulation on mortgage quality, average U.S. home prices rose more than 50% from the beginning of 2003 to the middle of 2006. This led to an unsustainable building boom—with echoes around the world in countries such as the U.K, Spain and Ireland. The bubbles in primary commodity prices collapsed mainly in the second half of 2008. But the residue of bad debts, particularly ongoing mortgage defaults, led to the banking crisis and global downturn of 2008-09.”
Mr. McKinnon is spot on, but he leaves out one fact. Long-term rates did not rise as was expected. Remember Mr. Greenspan’s so-called conundrum (when he claimed he did not fully understand why long-term rates were not rising as expected). The problem was that although private investors were leaving the dollar, many foreign investors (especially central banks and exporters) were buying U.S. treasuries to keep borrowing costs low, prevent the dollar from weakening further and to keep U.S. consumers spending.
Mr. McKinnon is correct that there are similarities between now and 2003. However there is one great difference: credit. The housing market remains impaired because only those with strong credit profiles can obtain loans and mortgages. Although credit maybe loosening, it is unlikely, not to mention unwise, to extend credit to those who cannot repay their debts. Without easy credit (or an industry rising to take the place of a once-robust housing market), core inflation could remain tame, unemployment fairly high and higher food and energy prices could dampen consumer spending. Who knows, maybe there is a commodity bubble?
One last note: This is earnings season. We have already seen two large banks report. Both reported lower-than-expected trading and capital markets earnings. With greater regulations coming on line, banks will need to maximize revenue from other areas. One such area is traditional banking. The current steep yield curve permits banks to generate significant revenues by borrowing on the short end of the curve at very low rates (LIBOR, etc.) and invest on the long end of the curve (10+ years out). For the recovery to continue, banks need to be able to lend profitably. This means a steep yield curve. Look for Fed policies to keep the yield curve steep. Next week’s FOMC meeting promises to be a non-event. Today’s NAHB Housing Market Index report indicates that progress remains slow.
Remember all the talk of foreign investors abandoning the U.S. dollar, that there will be few buyers for U.S. debt? Fears have not come to fruition, at least not yet. TIC data (foreign investor purchases of U.S. securities) indicate that foreign investors were in hot and heavy last November.
November data indicate a net inflow of foreign investment into U.S. securities of $39.0 billion. This is up from a prior revised $15.1B (up from $7,5B). Remember how investors, especially foreign investors, where going to specifically avoid the long end of the curve due to inflation concerns due to widening U.S. deficits and inflationary Fed policy? Well it appears as though someone forgot to tell foreign investors. Last November, the net inflow of foreign capital into long-dated U.S. debt was $85.1B. This was more than double the street estimate of $40.0B and a prior revised $28.9B (up from $27.6B). Remember, QE2 was launched in November, Rather than deterring foreign buyers, they were encouraged (for both investment and currency exchange reasons) to invest in dollars.
Thus far Fed policy has not led to much-feared higher inflation. Although long-term interest rates rebounded dramatically from their lows, they have stabilized near current levels as trades put on ahead of QE2 were unwound. However, some experts believe that inflation in the U.S. may be just over the horizon and is cropping up overseas now.
Stanford professor, Ronald McKinnon writes in today’s Wall Street Journal that Fed policy is helping to cause overseas inflation and that it is only a matter of time before the inflation wave arrives on our shores. Mr. McKinnon writes:
“What do the years 1971, 2003 and 2010 have in common? In each year, low U.S. interest rates and the expectation of dollar depreciation led to massive "hot" money outflows from the U.S. and world-wide inflation. And in all three cases, foreign central banks intervened heavily to buy dollars to prevent their currencies from appreciating.”
“When central banks issue base money to buy dollars, domestic interest rates are forced down and domestic inflationary pressure is generated. Primary commodity prices go up quickly because speculators can easily bid for long positions in organized commodity futures markets when interest rates are low.”
However, what may be different this time is the ability or willingness of consumers to borrow and spend. During the last such time of extremely “easy” Fed policy consumers were able to borrow and spend, often irresponsibly. The inability or unwillingness of consumers to borrow and spend may hold down so-called core inflation. That could alleviate the inflationary pressures on commodities. Mr. McKinnon warns that a second round of stagflation could lie ahead. Whether or not a repeat of the 1970s is in the cards remains to be seen. It all depends on actions and reactions of policy makers and consumers. However, Mr. McKinnon delivers a good synopsis of Paul Volcker’s success in defeating stagflation and responses by foreign central bankers. He also delivers a good synopsis of the most recent economic bubble. He writes:
“The Greenspan-Bernanke interest rate shock of 2003-04, followed by a weakening dollar into the first half of 2008, created the bubble economy. Primary commodity prices began rising significantly in 2003-04, then flattened out before spiking in 2007 into the first half of 2008.”
“But the biggest bubble was in real estate, both commercial and residential. With low mortgage rates and no restraining regulation on mortgage quality, average U.S. home prices rose more than 50% from the beginning of 2003 to the middle of 2006. This led to an unsustainable building boom—with echoes around the world in countries such as the U.K, Spain and Ireland. The bubbles in primary commodity prices collapsed mainly in the second half of 2008. But the residue of bad debts, particularly ongoing mortgage defaults, led to the banking crisis and global downturn of 2008-09.”
Mr. McKinnon is spot on, but he leaves out one fact. Long-term rates did not rise as was expected. Remember Mr. Greenspan’s so-called conundrum (when he claimed he did not fully understand why long-term rates were not rising as expected). The problem was that although private investors were leaving the dollar, many foreign investors (especially central banks and exporters) were buying U.S. treasuries to keep borrowing costs low, prevent the dollar from weakening further and to keep U.S. consumers spending.
Mr. McKinnon is correct that there are similarities between now and 2003. However there is one great difference: credit. The housing market remains impaired because only those with strong credit profiles can obtain loans and mortgages. Although credit maybe loosening, it is unlikely, not to mention unwise, to extend credit to those who cannot repay their debts. Without easy credit (or an industry rising to take the place of a once-robust housing market), core inflation could remain tame, unemployment fairly high and higher food and energy prices could dampen consumer spending. Who knows, maybe there is a commodity bubble?
One last note: This is earnings season. We have already seen two large banks report. Both reported lower-than-expected trading and capital markets earnings. With greater regulations coming on line, banks will need to maximize revenue from other areas. One such area is traditional banking. The current steep yield curve permits banks to generate significant revenues by borrowing on the short end of the curve at very low rates (LIBOR, etc.) and invest on the long end of the curve (10+ years out). For the recovery to continue, banks need to be able to lend profitably. This means a steep yield curve. Look for Fed policies to keep the yield curve steep. Next week’s FOMC meeting promises to be a non-event. Today’s NAHB Housing Market Index report indicates that progress remains slow.
Friday, January 14, 2011
The Recovery Steady As She Goes
Today’s economic data was decent. Not spectacular, but it does indicate the economy is recovering, albeit slowly (I sound like a broken record (does anyone remember what a record is?)). CPI was higher, than but not as much as yesterday’s PPI. This indicates that businesses still cannot fully pass along price increase to consumers. Backing out the volatile and speculation-fueled food and energy inflation data, inflation was very tame. However, even when food and energy prices are included, consumer prices are up only 1.5% year over year. This is not the stuff of which less accommodative Fed policies are made.
Investors who purchased three-year, 10-year and 30-year U.S. treasury debt at auction are probably feeling good about their purchases following today’s mild inflation data. All three auctions went well. The 10-year auction was the best of the three and even the 30-year auction was close to its average figures for the past 10 auctions. I continue to hear from financial advisors about warnings they are getting from wholesalers and equity types that inflation is poised to explode. We don’t see it. Apparently, neither do foreign central banks who were major purchasers of the 10-year treasury notes and 30-year government bonds at this week’s auctions. Maybe it is that they are determined to keep long-term rates low and to support the dollar (which helps to keep inflation contained) for their own benefits.
Retail sales were higher, but missed street expectations. It could be that the street is being overly optimistic. There is still the belief that the economy is going to rebound to activity levels experienced during the last two recoveries. I don’t see the fundamentals to support such a recovery. More importantly, neither do many economists and strategists. Most experts are forecasting sustainable, but modest recovery.
A Wall Street Journal survey of economists indicates a consensus GDP forecast for 2011 of 3.2% with unemployment falling to 8.8% by year end. There is nothing surprising about these forecasts. The fundamentals for rapid growth and low unemployment simply do not exist at this time. Today’s Capacity Utilization report indicates an improvement and much surplus capacity. This usually means that there is the job market is improving and there is plenty of room to create jobs. However, one must ask how surplus capacity is being measured. If current capacity is being measured versus capacity during the last two bubbles, then it is likely that this capacity is superfluous, rather than surplus.
Most fixed income professionals do not see dramatically higher interest rates, spiraling inflation and or a reversal of Fed policy in the near future. Please keep that in mind when considering a strategy or trade idea.
Investors who purchased three-year, 10-year and 30-year U.S. treasury debt at auction are probably feeling good about their purchases following today’s mild inflation data. All three auctions went well. The 10-year auction was the best of the three and even the 30-year auction was close to its average figures for the past 10 auctions. I continue to hear from financial advisors about warnings they are getting from wholesalers and equity types that inflation is poised to explode. We don’t see it. Apparently, neither do foreign central banks who were major purchasers of the 10-year treasury notes and 30-year government bonds at this week’s auctions. Maybe it is that they are determined to keep long-term rates low and to support the dollar (which helps to keep inflation contained) for their own benefits.
Retail sales were higher, but missed street expectations. It could be that the street is being overly optimistic. There is still the belief that the economy is going to rebound to activity levels experienced during the last two recoveries. I don’t see the fundamentals to support such a recovery. More importantly, neither do many economists and strategists. Most experts are forecasting sustainable, but modest recovery.
A Wall Street Journal survey of economists indicates a consensus GDP forecast for 2011 of 3.2% with unemployment falling to 8.8% by year end. There is nothing surprising about these forecasts. The fundamentals for rapid growth and low unemployment simply do not exist at this time. Today’s Capacity Utilization report indicates an improvement and much surplus capacity. This usually means that there is the job market is improving and there is plenty of room to create jobs. However, one must ask how surplus capacity is being measured. If current capacity is being measured versus capacity during the last two bubbles, then it is likely that this capacity is superfluous, rather than surplus.
Most fixed income professionals do not see dramatically higher interest rates, spiraling inflation and or a reversal of Fed policy in the near future. Please keep that in mind when considering a strategy or trade idea.
Thursday, January 13, 2011
Listen to the Headwinds Blow
Initial jobless claims ticked higher to 445,000 from a prior revised 410,000 and a street consensus of 410,000. Continuing claims fell to 3,879,000 from a prior revised 4,127,000. The street was looking for 4,088,000. Why the conflicting numbers? The numbers are not that conflicting when one considers that the initial claims data are from the week ending January 8th and the continuing claims data are from the week ending January 1st. Remember that last week’s initial claims also surprised to the low side. What may have caused the low reads for the week ending January 1st (the last week of December 2010) are seasonal adjustments and the blizzard and other inclement weather which impacted the eastern half of the Country. When people are snowed in they don’t go out to file unemployment claims. The higher-than-expected initial claims data for the week ending January 8th may have some “catch-up” within them. However, the four week average of initial claims has increased to 416,000. The four week average is considered to be a better indicator of initial claims as it includes revisions and smoothes the data which can include spikes and troughs.
The bottom line, folks are that the jobs market is improving modestly, much in the same way that the economy is recovering. The question remains: From where are jobs going to come? No one has the answer. All I hear from optimists is: job growth always follows. Have they stopped and considered that this is the job growth they have been waiting for?
An increase in temporary employment has long been considered a bellwether, portending permanent job growth, but the data does not support this phenomenon this time around. The number of temporary workers continues to grow, but has not translated into permanent employment, thus far. Also, workers who are finding jobs are often forced to accept lower compensation levels from what they were making prior to the “Great Recession.” Many investors and market participants believe that a return to “normal” is just around the corner. They are correct in that belief. Where they are wrong is their interpretation of normal. The tech and the housing bubbles wee not normal. In the coming years, average growth of 3.00% - 3.50% will probably be normal. Unemployment slowly dropping to around 7.00% will probably be normal. Technology, globalization and temporary jobs becoming a long-term fixture in the economy are structural changes to employment in the U.s. Home prices declining further before slowly rising is probably normal. Get used to it.
Former Delaware Senator Ted Kaufman was a guest this morning on CNBC’s Squawk Box show. He discussed auto bailouts and recovery with host Joe Kernan. Most of the conversation was just a rehashing of the auto bailouts and bankruptcies. However, the talk turned to moral hazards, specifically banks and sovereign nations. Mr. Kernan and Mr. Kaufman agreed that every company or government can or should always be bailed out. Where are the incentives for business executives or elected officials to act responsibly? Why should investors care about the credit quality and financial conditions of various entities? Bailouts have to be paid for. They are being paid for by taxpayers and consumers. Sometime in the future (possibly near future) investors are going to be whipsawed when a “too big to fail entity” fails or restructures debts.
PPI rose, mostly due to higher food and energy prices. Once again the question is: Can or will businesses pass cost increased onto consumers. At this point the answer is no (at least not fully). Many (if not most) businesses would rather erode profit margin or cut costs elsewhere (labor, energy use, etc.) than rises prices while the consumer is impaired and competitors are hungry for whatever business they can get,. CPI probably will not correlate with PPI. If it does, consumer spending could be hampered. Remembers, consumers are feeling the food and energy pain directly at the pump and at the grocery store. Higher food and energy prices tend to act as a regressive tax on consumption (regressive in that it affects lower-income consumers the most). Higher food and energy prices can be significant headwinds to growth if real consumer income does not rise in kind. There are very few signs of that happening now or in the near future.
The U.S trade balance narrowed thanks mainly to the weaker U.S. dollar fueling exports. However, the U.S. trade deficit with China widened. Please tell me again why China wants to strengthen the renminbi versus the dollar?
I have been home battling multiple ailments, but have been coming along. Who knows, maybe I will have to create a for-profit newsletter. Necessity is the mother of invention ~ Plato.
The bottom line, folks are that the jobs market is improving modestly, much in the same way that the economy is recovering. The question remains: From where are jobs going to come? No one has the answer. All I hear from optimists is: job growth always follows. Have they stopped and considered that this is the job growth they have been waiting for?
An increase in temporary employment has long been considered a bellwether, portending permanent job growth, but the data does not support this phenomenon this time around. The number of temporary workers continues to grow, but has not translated into permanent employment, thus far. Also, workers who are finding jobs are often forced to accept lower compensation levels from what they were making prior to the “Great Recession.” Many investors and market participants believe that a return to “normal” is just around the corner. They are correct in that belief. Where they are wrong is their interpretation of normal. The tech and the housing bubbles wee not normal. In the coming years, average growth of 3.00% - 3.50% will probably be normal. Unemployment slowly dropping to around 7.00% will probably be normal. Technology, globalization and temporary jobs becoming a long-term fixture in the economy are structural changes to employment in the U.s. Home prices declining further before slowly rising is probably normal. Get used to it.
Former Delaware Senator Ted Kaufman was a guest this morning on CNBC’s Squawk Box show. He discussed auto bailouts and recovery with host Joe Kernan. Most of the conversation was just a rehashing of the auto bailouts and bankruptcies. However, the talk turned to moral hazards, specifically banks and sovereign nations. Mr. Kernan and Mr. Kaufman agreed that every company or government can or should always be bailed out. Where are the incentives for business executives or elected officials to act responsibly? Why should investors care about the credit quality and financial conditions of various entities? Bailouts have to be paid for. They are being paid for by taxpayers and consumers. Sometime in the future (possibly near future) investors are going to be whipsawed when a “too big to fail entity” fails or restructures debts.
PPI rose, mostly due to higher food and energy prices. Once again the question is: Can or will businesses pass cost increased onto consumers. At this point the answer is no (at least not fully). Many (if not most) businesses would rather erode profit margin or cut costs elsewhere (labor, energy use, etc.) than rises prices while the consumer is impaired and competitors are hungry for whatever business they can get,. CPI probably will not correlate with PPI. If it does, consumer spending could be hampered. Remembers, consumers are feeling the food and energy pain directly at the pump and at the grocery store. Higher food and energy prices tend to act as a regressive tax on consumption (regressive in that it affects lower-income consumers the most). Higher food and energy prices can be significant headwinds to growth if real consumer income does not rise in kind. There are very few signs of that happening now or in the near future.
The U.S trade balance narrowed thanks mainly to the weaker U.S. dollar fueling exports. However, the U.S. trade deficit with China widened. Please tell me again why China wants to strengthen the renminbi versus the dollar?
I have been home battling multiple ailments, but have been coming along. Who knows, maybe I will have to create a for-profit newsletter. Necessity is the mother of invention ~ Plato.
Friday, January 7, 2011
Disappointing Jobs Data
Wednesday’s ADP number had the market very optimistic about today’s jobs data. Even normally even-keeled I was practically giddy. I went out on a limb for our informal contest on the desk and called for a gain of 165,000 jobs. Alas, it was not to be. The U.S. economy added 103,000 jobs. This is just a little over half the number of jobs believed necessary to keep up with the number of people entering the job market. Even the much-watched and very important Private Payrolls component disappointed adding 113,000 jobs. There was some good news in the report. November Non-farm Payrolls was revised higher to 71,000 from 39,000. November Private Payrolls was revised upward to 79,000 from 50,000.
The big story may be that the unemployment rate fell to 9.4% from 9.8%. The question immediately asked regarding the fall in the unemployment rate is: Has it fallen because significantly more Americans obtained employment or is it because many displaced workers became discouraged because they could not find meaningful employment? Remember, if a displaced worker answers the so-called household survey that they are not seeking employment at this time, they are not considered to be unemployed at the present time. Although a more complete parsing of the numbers is needed to determine the exact cause of the sharp drop of the unemployment rate, word on the Street is that discouraged workers (measured as workers leaving the workforce) increased last month. Also possibly affecting the unemployment rates is the expansion of unemployment benefits as part of the latest economic stimulus package (which includes the extension of the Bush tax cuts). It is possible that some displaced workers who were actively seeking employment now see the situation as being less urgent as the will continue to receive benefits for a while longer. The slow recovery continues. Here is what some market participants had to say:
“Firms must ratchet up hiring before we can expect
consistent trend growth for the economy. Slower job growth will weigh on
consumer spending for the next few quarters.”
“While it appears that the economic environment has
stabilized and is perhaps improving, persistent high
unemployment and uncertainty in the economy could continue to
pressure consumers and affect their spending,”
Where were the jobs created? The service sector added 105,000jobs. Retailers added 12,000 employees in December. The construction sector eliminated 16,000 jobs and state and local governments cut 20,000 jobs. This was tempered by the addition of 10,000 Federal Government jobs. The economy also added 16,000 temporary jobs. There was also a pickup hiring in the auto sector. Ford announced that it is planning to hire 1,800 new workers. This is significant. As per the new labor agreements, new workers at the “Detroit Three” automakers receive a much less attractive compensation package than legacy employees. This is something the UAW is looking to change.
Average Weekly Hours remained unchanged at 34.3. Average Hourly Earnings rose 1.8%, in line with the street consensus. Today’s numbers were not horrible, but they were disappointing, especially for those who believed that the U.S economy had turned a corner and was ready to gain speed. We are not there yet. However, we are not poised on the precipice of a double-dip recession either. Slow and steady with modestly-higher long-term rates and an accommodative Fed for at least 2011 (if not longer) appear to be in the cards, at least for now.
Fed Chairman Ben Bernanke stated this morning that he sees the economy improving in 2011, but not fast enough to appreciably lower unemployment. He believes that it could be four or five years before unemployment returns to "normal."
The real unemployment rate remains stubbornly high (just under 17%). Here is a link to the Bureau of Labor Statistics real unemployment data (U-6):
http://www.bls.gov/news.release/empsit.t15.htm
Play defense, invest wisely and have a great weekend.
The big story may be that the unemployment rate fell to 9.4% from 9.8%. The question immediately asked regarding the fall in the unemployment rate is: Has it fallen because significantly more Americans obtained employment or is it because many displaced workers became discouraged because they could not find meaningful employment? Remember, if a displaced worker answers the so-called household survey that they are not seeking employment at this time, they are not considered to be unemployed at the present time. Although a more complete parsing of the numbers is needed to determine the exact cause of the sharp drop of the unemployment rate, word on the Street is that discouraged workers (measured as workers leaving the workforce) increased last month. Also possibly affecting the unemployment rates is the expansion of unemployment benefits as part of the latest economic stimulus package (which includes the extension of the Bush tax cuts). It is possible that some displaced workers who were actively seeking employment now see the situation as being less urgent as the will continue to receive benefits for a while longer. The slow recovery continues. Here is what some market participants had to say:
“Firms must ratchet up hiring before we can expect
consistent trend growth for the economy. Slower job growth will weigh on
consumer spending for the next few quarters.”
“While it appears that the economic environment has
stabilized and is perhaps improving, persistent high
unemployment and uncertainty in the economy could continue to
pressure consumers and affect their spending,”
Where were the jobs created? The service sector added 105,000jobs. Retailers added 12,000 employees in December. The construction sector eliminated 16,000 jobs and state and local governments cut 20,000 jobs. This was tempered by the addition of 10,000 Federal Government jobs. The economy also added 16,000 temporary jobs. There was also a pickup hiring in the auto sector. Ford announced that it is planning to hire 1,800 new workers. This is significant. As per the new labor agreements, new workers at the “Detroit Three” automakers receive a much less attractive compensation package than legacy employees. This is something the UAW is looking to change.
Average Weekly Hours remained unchanged at 34.3. Average Hourly Earnings rose 1.8%, in line with the street consensus. Today’s numbers were not horrible, but they were disappointing, especially for those who believed that the U.S economy had turned a corner and was ready to gain speed. We are not there yet. However, we are not poised on the precipice of a double-dip recession either. Slow and steady with modestly-higher long-term rates and an accommodative Fed for at least 2011 (if not longer) appear to be in the cards, at least for now.
Fed Chairman Ben Bernanke stated this morning that he sees the economy improving in 2011, but not fast enough to appreciably lower unemployment. He believes that it could be four or five years before unemployment returns to "normal."
The real unemployment rate remains stubbornly high (just under 17%). Here is a link to the Bureau of Labor Statistics real unemployment data (U-6):
http://www.bls.gov/news.release/empsit.t15.htm
Play defense, invest wisely and have a great weekend.
Tuesday, January 4, 2011
Happy New Year
Recent feedback from the field indicates that higher interest rate fears are more prevalent among FAs and their clients than among fixed income professionals. Are these fears being stoked by wholesalers, newsletter authors or equity strategists? From what we have been told it is all of the above. There are very few fixed income pros calling for skyrocketing long-term interest rates and corresponding soaring inflation. Forecast data compiled from Bloomberg News bears this out.
Bloomberg News compiles forecasts for interest rates on various spots on the curve from economists around the industry. The consensus opinion places the 10-year U.S. treasury note yield in the area of 3.53% in the fourth quarter of 2011 based on the Bloomberg Weighted Average. The Q4 2011 median forecast is 3.51% as of this morning. Looking out into 2012 shows a weighted average 10-year U.S. treasury note forecast of 3.83% and a median forecast of 3.80% (however, fewer economists submitted forecasts for Q1 2012). Even Morgan Stanley, whose fixed income marketing desk has been suggesting floaters for higher interest rates (along with other bad, dangerous or misinformed strategies), forecasts a 3.75% 10-year note for Q4 2011. With few exceptions, the fixed income side of the business is not forecasting soaring long-term rates. Maybe I am biased, but I believe economists have a better handle on where rates are probably going than fund wholesalers and equity market participants.
What about the yield curve? Isn’t the yield curve forecasting strong growth, a booming stock market and higher inflation? The yield curve tells much, but predicts little. By that we mean that it reflects monetary policy on the short end and its expected effectiveness and inflation expectations on the long end. The yield curve reflects more than it predicts. One pundit was on CNBC this morning stating that the yield curve was predicting strong growth and a strong stock market. We thought that a Fed Funds rate which is effectively 0.00% and two rounds of quantitative easing were responsible for such expectations and the yield curve was a reflection of policies and expectations. The pundit defended his position by stating that the inverted yield curve seen just prior to the last recession was forecasting an economic downturn,
Excuse me for being so bold, but what would one expect after several years Fed tightening? Again, the yield curve was reflecting market sentiment based on monetary policy and expected results. If the yield curve was to be looked to as a predictor of the last recession one could argue that it underestimated the magnitude and severity of the downturn, However, if one accepts that fact that the yield curve is merely a reflection of market sentiment based on policy decisions and inflation expectations then the yield curve is useful as an economic barometer.
I am not a mutual fund expert. My focus is on individual bonds and custom-tailored portfolios. However, this is not to say that I do not pay attention to what is being said in the fixed income mutual fund business. The CEO of Thornburg Investment Management was on CNBC discussing his firm. He was asked how his fixed income funds have been able to perform well through a variety of economic and market conditions. His response was that Thornburg ladders maturities, diversifies and does not try to predict interest rates (time the market). We could not agree more. In our opinion, laddering is the best way to invest for income in the fixed income markets. Swapping should be kept to a minimum and probably should only be used to rebalance accounts to meet client goals, objectives and risk tolerances.
In closing we would like to address market inefficiencies. In today’s market the desire for yield is strong. There are few if any inefficiencies in which bonds are priced below their true values. If anything, many bonds are inordinately rich. If a bond looks exceptionally attractive for its credit rating ask a professional why this is so. Chances are that there is a negative story associated with that bond. Also, consider the source of the information or investment idea before acting.
Bloomberg News compiles forecasts for interest rates on various spots on the curve from economists around the industry. The consensus opinion places the 10-year U.S. treasury note yield in the area of 3.53% in the fourth quarter of 2011 based on the Bloomberg Weighted Average. The Q4 2011 median forecast is 3.51% as of this morning. Looking out into 2012 shows a weighted average 10-year U.S. treasury note forecast of 3.83% and a median forecast of 3.80% (however, fewer economists submitted forecasts for Q1 2012). Even Morgan Stanley, whose fixed income marketing desk has been suggesting floaters for higher interest rates (along with other bad, dangerous or misinformed strategies), forecasts a 3.75% 10-year note for Q4 2011. With few exceptions, the fixed income side of the business is not forecasting soaring long-term rates. Maybe I am biased, but I believe economists have a better handle on where rates are probably going than fund wholesalers and equity market participants.
What about the yield curve? Isn’t the yield curve forecasting strong growth, a booming stock market and higher inflation? The yield curve tells much, but predicts little. By that we mean that it reflects monetary policy on the short end and its expected effectiveness and inflation expectations on the long end. The yield curve reflects more than it predicts. One pundit was on CNBC this morning stating that the yield curve was predicting strong growth and a strong stock market. We thought that a Fed Funds rate which is effectively 0.00% and two rounds of quantitative easing were responsible for such expectations and the yield curve was a reflection of policies and expectations. The pundit defended his position by stating that the inverted yield curve seen just prior to the last recession was forecasting an economic downturn,
Excuse me for being so bold, but what would one expect after several years Fed tightening? Again, the yield curve was reflecting market sentiment based on monetary policy and expected results. If the yield curve was to be looked to as a predictor of the last recession one could argue that it underestimated the magnitude and severity of the downturn, However, if one accepts that fact that the yield curve is merely a reflection of market sentiment based on policy decisions and inflation expectations then the yield curve is useful as an economic barometer.
I am not a mutual fund expert. My focus is on individual bonds and custom-tailored portfolios. However, this is not to say that I do not pay attention to what is being said in the fixed income mutual fund business. The CEO of Thornburg Investment Management was on CNBC discussing his firm. He was asked how his fixed income funds have been able to perform well through a variety of economic and market conditions. His response was that Thornburg ladders maturities, diversifies and does not try to predict interest rates (time the market). We could not agree more. In our opinion, laddering is the best way to invest for income in the fixed income markets. Swapping should be kept to a minimum and probably should only be used to rebalance accounts to meet client goals, objectives and risk tolerances.
In closing we would like to address market inefficiencies. In today’s market the desire for yield is strong. There are few if any inefficiencies in which bonds are priced below their true values. If anything, many bonds are inordinately rich. If a bond looks exceptionally attractive for its credit rating ask a professional why this is so. Chances are that there is a negative story associated with that bond. Also, consider the source of the information or investment idea before acting.
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