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.
Friday, January 14, 2011
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.
Wednesday, December 22, 2010
2011 Outlook
Happy Holidays
2011 Outlook
The Holidays are here and 2011 will soon be upon us. With liquidity scare from now through year-end 2011 should be the focus of all fixed income investors. 2011 is going to tell us much. It will tell us if the EU will hold together. It will tell us if the euro can survive as a currency. It will tell us if centralized monetary policy and localized fiscal policies is a feasible model in the long-term. 2011 will also tell us what a non-bubble U.S. expansion looks like.
Europe is going to be interesting. Its problems are not going to be solved with bailout funds and strong language. Troubled countries are either going to cut benefits to its citizens, adopt pro-growth policies or leave the euro and try to devalue their way out of their problems. The list of troubled countries may be expanding. Belgium may join the PIIGS among troubled European countries. I still haven’t come with a new acronym. The bottom line is that Europeans have some difficult choices to make.
One choice which will probably not be available is to continue with their market / welfare state hybrid while being part of a common currency. The ECB can do little to help distressed countries because it can’t ease or engage in QE to help a country like Greece without damaging the economies of countries like Germany. One way to solve this dilemma would be to give the EU the authority to dictate both fiscal and monetary policy for the entire bloc, a United Stated of Europe if you will. However, that would require member countries to give up their sovereignty and adhere to rules set by a central governing body. This will not go over well among the European populace. Although its demise is not certain make no mistake, the euro is in trouble.
Closer to home we will soon see what the economic potential of a non-bubble-fueled U.S. economy looks like. Economic data during the first half of 2011 will be positively affected by the extension of the Bush-era tax cuts and the suspension of the worker portion of the payroll tax. However as with all temporary stimulus measures, the benefits are likely to be short-lived and less affective than anticipated. By the end of 2011, the U.S. economy will have to fly on its own power. Not all stimulus will be removed. It is unlikely that the Fed will engage in QE3, but it is unlikely to raise rates in 2011.
Long-term rates may not have far to rise in 2011. The recent rise of long-term rates is mostly a correction following a smaller than anticipated QE2 program and better growth outlook. Current long-term rates probably have GDP between 3.50% and 4.00% mostly built in. We could see a 4.00% 10-year note by the end of 2011, but maybe not much higher. If the economy cannot gain more traction, long-term rates could languish in the mid-3.00% area. In fact, Philadelphia Fed President Charles Plosser, who has been one of the more hawkish and optimistic Fed officials gave his 2011 estimate today. He forecasts that 2011 will be in the 3.00% to 3.50% area.
Fixed income investing in this environment is not that difficult, if one manages expectations. Ladder your portfolio. Resist swapping into “sexy” products or overweighting on the long end of the curve (or the short end of the curve). Invest new money on the belly of the curve (5-10 years) unless that runs counter to your goals, objectives or risk tolerances. TIPS are rich. The break even between 10-year TIPS and the 10-year treasury is 230 basis points. With inflation likely to be tamer than what the alarmists are predicting us TIPS only as hedging vehicle. Watch out for bubbles in very-low-rated bonds (low B and CCC) and a correction in investment grade industrials. Financials, insurance and, to a lesser extent, telecom offer the best values.
Investors should consider callable agency bonds, including step-ups. I also believe that corporate step-ups offer value, more than do LIBOR-based floaters. CPI corporate floaters may be a better option. Not because inflation is going to run, but because even modest increases in inflation will be greater than what occurs in three-month LIBOR (the typical benchmark for floaters) as it is joined at the hip with Fed Funds and the Fed is not budging in 2011. Not unless housing takes off, removing significant headwinds facing the economy, but that probably will not happen.
Until next year.
2011 Outlook
The Holidays are here and 2011 will soon be upon us. With liquidity scare from now through year-end 2011 should be the focus of all fixed income investors. 2011 is going to tell us much. It will tell us if the EU will hold together. It will tell us if the euro can survive as a currency. It will tell us if centralized monetary policy and localized fiscal policies is a feasible model in the long-term. 2011 will also tell us what a non-bubble U.S. expansion looks like.
Europe is going to be interesting. Its problems are not going to be solved with bailout funds and strong language. Troubled countries are either going to cut benefits to its citizens, adopt pro-growth policies or leave the euro and try to devalue their way out of their problems. The list of troubled countries may be expanding. Belgium may join the PIIGS among troubled European countries. I still haven’t come with a new acronym. The bottom line is that Europeans have some difficult choices to make.
One choice which will probably not be available is to continue with their market / welfare state hybrid while being part of a common currency. The ECB can do little to help distressed countries because it can’t ease or engage in QE to help a country like Greece without damaging the economies of countries like Germany. One way to solve this dilemma would be to give the EU the authority to dictate both fiscal and monetary policy for the entire bloc, a United Stated of Europe if you will. However, that would require member countries to give up their sovereignty and adhere to rules set by a central governing body. This will not go over well among the European populace. Although its demise is not certain make no mistake, the euro is in trouble.
Closer to home we will soon see what the economic potential of a non-bubble-fueled U.S. economy looks like. Economic data during the first half of 2011 will be positively affected by the extension of the Bush-era tax cuts and the suspension of the worker portion of the payroll tax. However as with all temporary stimulus measures, the benefits are likely to be short-lived and less affective than anticipated. By the end of 2011, the U.S. economy will have to fly on its own power. Not all stimulus will be removed. It is unlikely that the Fed will engage in QE3, but it is unlikely to raise rates in 2011.
Long-term rates may not have far to rise in 2011. The recent rise of long-term rates is mostly a correction following a smaller than anticipated QE2 program and better growth outlook. Current long-term rates probably have GDP between 3.50% and 4.00% mostly built in. We could see a 4.00% 10-year note by the end of 2011, but maybe not much higher. If the economy cannot gain more traction, long-term rates could languish in the mid-3.00% area. In fact, Philadelphia Fed President Charles Plosser, who has been one of the more hawkish and optimistic Fed officials gave his 2011 estimate today. He forecasts that 2011 will be in the 3.00% to 3.50% area.
Fixed income investing in this environment is not that difficult, if one manages expectations. Ladder your portfolio. Resist swapping into “sexy” products or overweighting on the long end of the curve (or the short end of the curve). Invest new money on the belly of the curve (5-10 years) unless that runs counter to your goals, objectives or risk tolerances. TIPS are rich. The break even between 10-year TIPS and the 10-year treasury is 230 basis points. With inflation likely to be tamer than what the alarmists are predicting us TIPS only as hedging vehicle. Watch out for bubbles in very-low-rated bonds (low B and CCC) and a correction in investment grade industrials. Financials, insurance and, to a lesser extent, telecom offer the best values.
Investors should consider callable agency bonds, including step-ups. I also believe that corporate step-ups offer value, more than do LIBOR-based floaters. CPI corporate floaters may be a better option. Not because inflation is going to run, but because even modest increases in inflation will be greater than what occurs in three-month LIBOR (the typical benchmark for floaters) as it is joined at the hip with Fed Funds and the Fed is not budging in 2011. Not unless housing takes off, removing significant headwinds facing the economy, but that probably will not happen.
Until next year.
Wednesday, December 15, 2010
Right Said Fed
The November Advance Retail Sales came in better than expected as generous discounts and more optimistic consumers kicked off the holiday shopping season in a big way. Target and Macys were among the retailers reporting strong sales in November, largely due to impressive Thanksgiving sales.
One economist told Bloomberg News:
"Holiday sales are looking pretty good. Consumer spending will steadily improve in coming months. We're seeing a better overall economic outlook."
The street consensus if for improved consumer spending, but considering how poor consumer spending had been, even a big improvement could still leave consumer spending below to what we have become accustomed this far into a recovery. With unemployment expected to remain high and the housing market likely to remain impaired for several more years, consumer spending will likely rise slowly,
A sign that consumer spending is more than holiday driven is the report by Home Depot which indicated that sales of plumbing and electrical supplies rose. Although it is possible that many handy people are going to get what they want for Christmas, Home Depot's results look to be a sign that the pick up in consumer spending is more broadly based. On the down side, electronics retailer Best Buy reported worse-than-expected earnings as discounters such as Amazon and Wal-Mart are providing stiff competition
The headline PPI figure was up .8% versus a prior number of .4% (month-over-month) However, core PPI (MoM) came in at .4%, the smallest increase in five months. Much of the core PPI gain was due to higher energy prices (although egg prices were up a whopping 23%). How much will this influence CPI? Probably not that much. High unemployment, reduced household wealth and a fierce battle for market share are preventing businesses from passing price increases onto consumers. Raising prices is an almost sure way to lose market share in this environment. Instead businesses increase productivity by purchasing more efficient equipment or send jobs to lower-labor regions. This is helping to moderate the employment recovery.
The Fed will announce its rate decision this afternoon, there should be no surprises. The Fed will leave the Fed Funds target rate at between 0.00% and 0.25%. It is likely to reinforce its commitment to QE2, but its statement may very well have a more positive tone as to the strength and pace of the recovery.
The question which is being asked across the industry (across the country, actually), is: Is QE2 working. One could argue is that QE2 has sparked inflation fears in many areas of the economy, but has not helped to boost prices in the sector for which the Fed had hoped to see higher prices, real estate. However, some experts believe that Fed policies are working.
In today's Wall Street Journal, Wharton Professor Jeremy Siegel opines that QE2 is working and the sign that is working is higher treasury yields. Higher yields in among U.S. treasuries have been pointed to as a sign that Fed policy has been a failure based on the belief that QE2 has pushed bond yields and mortgage rates higher due to increased inflation fears because the Fed is causing the government to print money. This is the so-called vigilante theory.
Mr. Siegel argues that the real reason rate have been rising is that the bind market is becoming more optimistic that the economic recovery is strengthening, He states:
"Long-term Treasury rates are influenced positively by economic growth-which encourages consumers to borrow in anticipation of higher incomes and causes firms to seek funds to expand capacity-and by inflationary expectations. Long-term Treasury rates are affected negatively by risk aversion: Seeking a safe haven, investors pile into Treasury bonds, running up their prices and lowering their yields."
Mr. Siegel gets no argument from us, but bond yields are up for a variety of reasons. One reason is certainly due to better growth prospects. However, some of it is due to inflation fears due to the printing of money (we would argue that most of the vigilantism was in response to the tax cut extensions). Seemingly lost in this discussion is that fact that in the months leading up to the launch of QE2, many market participants purchased large amounts of U.S. treasuries on the beliefs that the size of QE2 would be much larger (some thought it would be nearly twice the size of what actually launched) and that the Fed would also target the very long end of the yield curve. Neither scenario played out.
There has been much talk about how the bull market in binds is over. No kidding, When the 10-year treasury note was around 2.50%, did any responsible person really believe it was going much lower (higher in price)? And if so, did any responsible person really believe it would stay there for a long period of time. Look at where long-term U.S. interest rates are, currently. If they rose 50 or even 100 basis points they would still be on the historically low side.
Just because the bull market is over does not mean that the bear market will push rates bank to what were common in the early 1980s. It does not even mean that they will rise to where they were in the early 1990s. All it means is that the probabilities for a double-dip recession of lessened and that the market has readjusted. Of course if one has laddered and diversified one's portfolio, one probably has little angst over where rates are going.
One economist told Bloomberg News:
"Holiday sales are looking pretty good. Consumer spending will steadily improve in coming months. We're seeing a better overall economic outlook."
The street consensus if for improved consumer spending, but considering how poor consumer spending had been, even a big improvement could still leave consumer spending below to what we have become accustomed this far into a recovery. With unemployment expected to remain high and the housing market likely to remain impaired for several more years, consumer spending will likely rise slowly,
A sign that consumer spending is more than holiday driven is the report by Home Depot which indicated that sales of plumbing and electrical supplies rose. Although it is possible that many handy people are going to get what they want for Christmas, Home Depot's results look to be a sign that the pick up in consumer spending is more broadly based. On the down side, electronics retailer Best Buy reported worse-than-expected earnings as discounters such as Amazon and Wal-Mart are providing stiff competition
The headline PPI figure was up .8% versus a prior number of .4% (month-over-month) However, core PPI (MoM) came in at .4%, the smallest increase in five months. Much of the core PPI gain was due to higher energy prices (although egg prices were up a whopping 23%). How much will this influence CPI? Probably not that much. High unemployment, reduced household wealth and a fierce battle for market share are preventing businesses from passing price increases onto consumers. Raising prices is an almost sure way to lose market share in this environment. Instead businesses increase productivity by purchasing more efficient equipment or send jobs to lower-labor regions. This is helping to moderate the employment recovery.
The Fed will announce its rate decision this afternoon, there should be no surprises. The Fed will leave the Fed Funds target rate at between 0.00% and 0.25%. It is likely to reinforce its commitment to QE2, but its statement may very well have a more positive tone as to the strength and pace of the recovery.
The question which is being asked across the industry (across the country, actually), is: Is QE2 working. One could argue is that QE2 has sparked inflation fears in many areas of the economy, but has not helped to boost prices in the sector for which the Fed had hoped to see higher prices, real estate. However, some experts believe that Fed policies are working.
In today's Wall Street Journal, Wharton Professor Jeremy Siegel opines that QE2 is working and the sign that is working is higher treasury yields. Higher yields in among U.S. treasuries have been pointed to as a sign that Fed policy has been a failure based on the belief that QE2 has pushed bond yields and mortgage rates higher due to increased inflation fears because the Fed is causing the government to print money. This is the so-called vigilante theory.
Mr. Siegel argues that the real reason rate have been rising is that the bind market is becoming more optimistic that the economic recovery is strengthening, He states:
"Long-term Treasury rates are influenced positively by economic growth-which encourages consumers to borrow in anticipation of higher incomes and causes firms to seek funds to expand capacity-and by inflationary expectations. Long-term Treasury rates are affected negatively by risk aversion: Seeking a safe haven, investors pile into Treasury bonds, running up their prices and lowering their yields."
Mr. Siegel gets no argument from us, but bond yields are up for a variety of reasons. One reason is certainly due to better growth prospects. However, some of it is due to inflation fears due to the printing of money (we would argue that most of the vigilantism was in response to the tax cut extensions). Seemingly lost in this discussion is that fact that in the months leading up to the launch of QE2, many market participants purchased large amounts of U.S. treasuries on the beliefs that the size of QE2 would be much larger (some thought it would be nearly twice the size of what actually launched) and that the Fed would also target the very long end of the yield curve. Neither scenario played out.
There has been much talk about how the bull market in binds is over. No kidding, When the 10-year treasury note was around 2.50%, did any responsible person really believe it was going much lower (higher in price)? And if so, did any responsible person really believe it would stay there for a long period of time. Look at where long-term U.S. interest rates are, currently. If they rose 50 or even 100 basis points they would still be on the historically low side.
Just because the bull market is over does not mean that the bear market will push rates bank to what were common in the early 1980s. It does not even mean that they will rise to where they were in the early 1990s. All it means is that the probabilities for a double-dip recession of lessened and that the market has readjusted. Of course if one has laddered and diversified one's portfolio, one probably has little angst over where rates are going.
Friday, December 3, 2010
Make Up Your Mind
Just when it you thought it was safe to believe that the economy was gaining some steam, today's data poured water on the fire. Nonfarm payrolls came in with a disappointing 39,000 new jobs in the month of November. Even when one considers the upward revision of 21,000 jobs for the October that only equals a total of 60,000 new jobs. The two-month average of approximately 105,000 new jobs per month, roughly half the number of jobs needed to lower the unemployment rate.
The private payrolls data, considered to be a better measure of unemployment recovery, due to the importance of the private sector in the U.S. economy, was also disappointing reporting only 50,000 new jobs with an upward revision of 1,000 additional jobs to the October data. This is quite a disappointment given last Wednesday’s better-than-expected ADP employment data.
Not surprisingly the markets initially reacted negatively to the data then recovered significantly. The reason for the recovery was said to be the belief that payrolls data for November may be a negative outlier. Supporters of this theory point to the strong ADP number. I cry foul on this. Why do I cry foul? The ADP report (a measure of private payrolls) has undershot the private payrolls component of the establishment survey. Critics have pointed to this and decried the ADP report as being unreliable as it underestimates the employment recovery. Not with the ADP report overshooting today’s private sector data, it is ADP which is being called accurate and the establishment data is now deemed to be unreflective of the job market recovery.
Beware of pundits, market participants and strategists who cherry-pick data for their own needs. Economists put far more value in the Nonfarm Payrolls data and its private sector component for a reason. It is more broad-based and tells a more complete and accurate story. Blind market bulls cannot have it both ways,
As if the Nonfarm Payrolls report wasn’t depressing enough, the Unemployment Rate report offered no comfort. The unemployment rate rose to 9.8% from 9.6%. Often during an economic recovery the unemployment rates will trend higher as discouraged displaced workers become more optimistic and answer the so-called household survey that they are now looking for work. However, that was not the case this time around. The unemployment rate rose due to more Americans being laid off.
I don’t often find much valuable commentary on CNBC. I believe that CNBC really stands for Constantly Naively Bullish Channel. However, today one guest speaker (whose name I did not hear) made a poignant observation. He stated that maybe the impact of technology on productivity is being underestimated and the impetus for large-scale hiring just isn’t there, in spite of the pick up in economic activity. I have heard that before, but I can’t remember where. ;)
Today’s soft jobs data should not come as a complete surprise. Fed Chairman Bernanke has been warning that the economic recovery is sluggish and job growth is impaired. This is why the Fed engaged in QE2 and could very well leave the Fed Funds rate unchanged well into 2012.
Fed policy is causing some inflation concerns. This is not surprising as the Fed as acknowledged it is trying to accomplish just that. However, the benchmark from which to gauge the bond market’s inflation concerns has changed. For almost a decade, the 10-year treasury note was the long-term benchmark for inflation concerns. This was because of the suspension of 30-year government bond issuance in 2001 and because a comparatively small float (amount issued) compared with the 10-year since 30-year auctions resumed a few years ago. Now with Fed making about 1/5th of its purchases in the 10-year area, the 10-year yield, although higher recently, is probably too low to accurately reflect inflation concerns. The long bond has regained its status as the long-term inflation benchmark.
What does the long bond yield tell me? That inflation pressures may increase, but there is no need to buy a wheel barrow to haul grocery money to the store. Sure, we could see 5.00% by 2012, but I doubt we will see inflation strong enough to push long-term rates much higher, not unless we can create another bubble.
There is a debate as to what is and isn’t inflation. There is a stupid YouTube video circulating explaining QE2 and why it makes not sense. The video appears to have been made by an Intellectually-challenged NPR intern using a kiddy V-Tech computer. The video asks why the Fed does not see inflation when food, energy, healthcare and tuition costs are higher.
Obviously this gadfly does not understand demand curves and taxes on consumption from price increases in sectors which have inelastic demand curves. He or she also does not understand that producers cannot pass price increases through to consumers. I don’t know about you, but I am paying less for clothing, vehicles, electronics and various other goods and services.
The area experiencing severe deflation is housing. Not only is the Fed largely responsible for the small amount of inflation pressures we are experiencing, but it is the only thing standing in the way of a collapse in housing prices.
I am not defending the Fed. I am only explaining why it is concerned with deflation and why it has engaged in QE2. If it were up to me I would let home prices reset to levels at which people could afford to purchase them. There are many people who cannot obtain a mortgage for a $500,000 home, but could for a $300,000 home. However, letting prices reset would not only blow up many influential investors in mortgage securities, it could impair the banks, including some large banks. The Fed does not want FC2 (Financial Crisis 2). QE2 is much more palatable. However, it will extend the time needed to turn the economy around, not until the glut of available homes is absorbed by the market will the economy recover.
The private payrolls data, considered to be a better measure of unemployment recovery, due to the importance of the private sector in the U.S. economy, was also disappointing reporting only 50,000 new jobs with an upward revision of 1,000 additional jobs to the October data. This is quite a disappointment given last Wednesday’s better-than-expected ADP employment data.
Not surprisingly the markets initially reacted negatively to the data then recovered significantly. The reason for the recovery was said to be the belief that payrolls data for November may be a negative outlier. Supporters of this theory point to the strong ADP number. I cry foul on this. Why do I cry foul? The ADP report (a measure of private payrolls) has undershot the private payrolls component of the establishment survey. Critics have pointed to this and decried the ADP report as being unreliable as it underestimates the employment recovery. Not with the ADP report overshooting today’s private sector data, it is ADP which is being called accurate and the establishment data is now deemed to be unreflective of the job market recovery.
Beware of pundits, market participants and strategists who cherry-pick data for their own needs. Economists put far more value in the Nonfarm Payrolls data and its private sector component for a reason. It is more broad-based and tells a more complete and accurate story. Blind market bulls cannot have it both ways,
As if the Nonfarm Payrolls report wasn’t depressing enough, the Unemployment Rate report offered no comfort. The unemployment rate rose to 9.8% from 9.6%. Often during an economic recovery the unemployment rates will trend higher as discouraged displaced workers become more optimistic and answer the so-called household survey that they are now looking for work. However, that was not the case this time around. The unemployment rate rose due to more Americans being laid off.
I don’t often find much valuable commentary on CNBC. I believe that CNBC really stands for Constantly Naively Bullish Channel. However, today one guest speaker (whose name I did not hear) made a poignant observation. He stated that maybe the impact of technology on productivity is being underestimated and the impetus for large-scale hiring just isn’t there, in spite of the pick up in economic activity. I have heard that before, but I can’t remember where. ;)
Today’s soft jobs data should not come as a complete surprise. Fed Chairman Bernanke has been warning that the economic recovery is sluggish and job growth is impaired. This is why the Fed engaged in QE2 and could very well leave the Fed Funds rate unchanged well into 2012.
Fed policy is causing some inflation concerns. This is not surprising as the Fed as acknowledged it is trying to accomplish just that. However, the benchmark from which to gauge the bond market’s inflation concerns has changed. For almost a decade, the 10-year treasury note was the long-term benchmark for inflation concerns. This was because of the suspension of 30-year government bond issuance in 2001 and because a comparatively small float (amount issued) compared with the 10-year since 30-year auctions resumed a few years ago. Now with Fed making about 1/5th of its purchases in the 10-year area, the 10-year yield, although higher recently, is probably too low to accurately reflect inflation concerns. The long bond has regained its status as the long-term inflation benchmark.
What does the long bond yield tell me? That inflation pressures may increase, but there is no need to buy a wheel barrow to haul grocery money to the store. Sure, we could see 5.00% by 2012, but I doubt we will see inflation strong enough to push long-term rates much higher, not unless we can create another bubble.
There is a debate as to what is and isn’t inflation. There is a stupid YouTube video circulating explaining QE2 and why it makes not sense. The video appears to have been made by an Intellectually-challenged NPR intern using a kiddy V-Tech computer. The video asks why the Fed does not see inflation when food, energy, healthcare and tuition costs are higher.
Obviously this gadfly does not understand demand curves and taxes on consumption from price increases in sectors which have inelastic demand curves. He or she also does not understand that producers cannot pass price increases through to consumers. I don’t know about you, but I am paying less for clothing, vehicles, electronics and various other goods and services.
The area experiencing severe deflation is housing. Not only is the Fed largely responsible for the small amount of inflation pressures we are experiencing, but it is the only thing standing in the way of a collapse in housing prices.
I am not defending the Fed. I am only explaining why it is concerned with deflation and why it has engaged in QE2. If it were up to me I would let home prices reset to levels at which people could afford to purchase them. There are many people who cannot obtain a mortgage for a $500,000 home, but could for a $300,000 home. However, letting prices reset would not only blow up many influential investors in mortgage securities, it could impair the banks, including some large banks. The Fed does not want FC2 (Financial Crisis 2). QE2 is much more palatable. However, it will extend the time needed to turn the economy around, not until the glut of available homes is absorbed by the market will the economy recover.
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