Staking Claims

Initial jobless claims unexpectedly rose by 24,000 to 484,000. A Labor Department spokesman attempted to explain it away by saying it due to administrative factors surrounding Easter. Why is it that when the number is unexpectedly good it is credited to an improving economy, but the number is poorer than expected it is claimed on various formulaic phenomena? The truth is that the economy is healing, but greater economic activity is required to support a given number of jobs than in the past.

Another truth is that the magnitude of the economic activity we saw during the last two expansions is fundamentally unsustainable given the current population. Banks will not lend irresponsibly because investors are wise to their "creative" structures. In the long run, it is better for the U.S., even if many in our business would rather have roaring markets now, regardless of the long-term cost.

The economy is rebounding to be sure. After all, business and consumers have basically spent nothing for a year. Items wear out,. Cars need to be replaced or repaired. Clothing must be purchased. Those who are gainfully employed and have access to credit are coming off of the sidelines to spend. If we all manage are expectations to account for a sustained growth level more in line with the U.S. historical average of about 3.00%, there is money to be made in this market. If we are anticipating a return to annual doubling of home prices, piggy bank home equity and mortgages for all, we will be disappointed.

This morning's strong Empire Manufacturing and Industrial Production reports bear out the recovery, but the Capacity Utilization Report, which came in at 73.2% (from from a prior revised 7.30%, but below an expected 73.3% indicates much slack in the economy. The real question is: Is there really excess capacity which will be used or is it that the U.S. has no use for much of its prior capacity to produce.

What did the bond market think of today's numbers? It put at least much weight on the poor jobless claims numbers as it did the stronger manufacturing data.

There is a great article on page C9 of today's Wall Street Journal. Apparently the short-term funds are up to their old tricks. During the last period of low short-term rates, short-term funds would juice yields buy using auction-rate securities (some tied to asset-backed structures) and asset-backed commercial paper. This time around the short-term funds are using floating rate securities with long maturities. They justify this by pointing their effective duration calculations, which calculate to a short-term number due to the formulas accounting of the floating coupon. However, we know that very few floaters are structured to stay at or near par in all situations. Most are structured to favor the issuer, not the investors, under most scenarios. This could leave investors exposed to rising rates on the long end of the curve. Why, because the coupons on the majority of these securities reset off of LIBOR or some other short-term benchmark. A security having a long-term maturity and a short-term coupon benchmark tend to perform better when the yield curve is flat or inverted and worse when the curve is steep and positively sloped (this is what makes floating-rate preferreds a poor choice versus high-coupon fixed rate issues). Remember, if a short-term fund is offering returns which are substantially higher than short-term benchmarks, it is not because of clever trading of t-bills

What to buy: Short-term - CDS. 5-7 years: Callable agencies. 7-10: Large bank bonds. Over 10: Avoid.