September 30, 2005
CHOOSE WISELY, GRASSHOPPER
After the tech bubble burst in 2000, the proverbial house cleaning of the speculative mess mercilessly swept aside the weak players, of which there were many. But as Nietzsche said, whatever doesn't kill you makes you stronger. True for one's soul, true for companies. Indeed, the tech survivors are a stronger, and in many cases smarter lot. Business plans are something more than the back-of-the-envelope variety that was infamous in the late-1990s in the dot-com boom. Meanwhile, the large, established tech firms in many instances have learned how to play the game with a nimbler hand.
In one corner of the tech landscape are the innovators of application, merging media with the Internet, computers with content. Among the leaders blazing a trail in this space are the likes of Google, Yahoo, Ebay and Amazon. Meanwhile, the suppliers of chips, components, and other tech gear are a chastened bunch, but arguably enlightened as well. The days of building supply a la the glut of fiber-optic cable in the '90s with the hope that demand would soon follow has been replaced by a more sober-minded approach that's as marketing savvy as it is profits seeking. Apple Computer's success of late with its iPod series of digital music players comes to mind as the gold standard in this niche.
Tech-related business opportunities seem to have rebounded as well, or so recent news stories suggest. Ebay's recent announcement that it would purchase Skype, the popular Internet phone-service provider, is an example. Meanwhile, Yahoo continues to forge ahead in trying to turn itself into a media firm of sorts, raising the bar on traditional media companies to respond. Then there's Google, whose success in going public is the closest thing to a hot Internet story on par with the late 1990s, albeit with the revenue muscle to support the hype.
So why isn't Mr. Market interested in tech stocks? Does the pain of the tech bust of a few years back still weigh heavily? Or is the world of technology still a volatile one where earnings growth is far less reliable than in, say, health care? Indeed, Microsoft, a former darling of investors, is showing a middle-age stupor. Having grown large and dominant, and arguably fat and lazy, it's not quite sure what to do in the 21st century, as its meandering, at best, stock price of late suggests.
Survival, in short, doesn't automatically translate into grand investment returns, at least not in the short term. Wall Street seems inclined to maintain a wait-and-see approach with tech stocks generally. Among the ten big-cap sectors that comprise the S&P 500, information technology companies have shed a bit more than 1% year to date through September 29, according to Standard & Poor's, vs. a 1.3% rise for big-cap stocks generally, as measured by the S&P 500. Small-cap tech stocks have lost even more this year, posting a 3.4% loss through yesterday. Mid-cap tech equities have fared better, albeit just barely with a tiny year-to-date rise of 0.2% through September 29. Tech has survived, but the days of sexy returns have faded, at least for the moment.
You want sizzling performance? Energy's your game these days. The energy sector for the S&P 500 has roared ahead by more than 42% this year through September 29. The gains are even more impressive among the small-cap S&P 600's energy sector, which soared 62% year to date.
Are tech stocks destined to remain unloved? That depends on the tech stocks you're talking about. Unlike some sectors, such as energy, where virtually everything is running higher, stock picking remains essential in the tech land. The biggest tech names in the S&P 500 serves as a reminder: In 2005, through September 29, Microsoft lost 2.9% while Intel rose by 4.7%. Divergence is also common elsewhere among the leading tech-savvy firms. Ebay, for instance, is down by 29% so far this year, and Yahoo's off by more than 11%. Google, on the other hand, has climbed over 60%.
Diversity of return can be found in the smaller tech stocks too. Consider some of the more prominent names in the small-cap S&P 600. Among the Internet Software & Services group in the index, Websense posts a meager 1.7% year-to-date rise in 2005, while Digital Insight's climbed over 40%. Even among the nearly 300 so-called technology mutual funds in Morningstar's database show a penchant for varied results. For the year through the end of August, the extreme ends of total returns range from 12% down to -13.6%.
Perhaps it's all a reflection of the volatility that defines tech. Today's giants are threatened by some wiz kid working in his garage. Big Oil, by comparison, never loses a wink of sleep over such things.
Technology is in the end about choice, change, evolution, and reordering the rules. Therein lies its opportunity, as well as its risk. Meanwhile, there's choice, and plenty of it, for both consumers and investors. It's hard to imagine a sector where indexing has lesser appeal than in tech.
September 29, 2005
WAITING FOR THE REBALANCING
Everyone's talking about it, but will anything come of it? And if so, when?
The Wall Street Journal today weighs in again on the subject of a global economic rebalancing, a topic's that's no stranger to these digital pages or any self-respecting economic pessimist. For those who are new to this corner of the dismal science, the basic outline runs thus: the United States spends too much, saves too little, while the rest of the world saves a lot (arguably too much) and spends too little, at least from America's consumer centric perspective.
It's been a cozy little relationship, to be sure, with America increasingly turning to foreigners to supply the capital that the U.S. economy can't. As a result, America has evolved from a creditor nation as recently as 20 years ago to a debtor nation and now owes $2.5 trillion to foreigners, writes David Wessel in today's Wall Street Journal (subscription required).
The great debate revolves around when America's red ink will start shrinking rather than growing, and what conditions will accompany that shrinkage. The answer may or may not be imminent, but its arrival will have wide-ranging implications for the dollar, the U.S. and global economies, the financial markets, just to name a few items. Minds differ over whether the rebalancing will enter with a bang (recession, sharp dollar devaluation, etc.) or a whimper (a relatively smooth, painless transition). Step right up and take your choice.
While the world waits for fate to render a verdict, Joe Sixpack and his friends are in no shape to weather a bang. The American Bankers Association yesterday reported that credit-card delinquencies reached a record high in this year's second quarter. Soaring gas prices are said to be a key reason. But debt is debt, and what it spawns won't be mitigated because of extraordinary events. In fact, high energy prices may not be so extraordinary going forward, but we digress.
Yet optimism is far from dead. "I'm not sure it's time to ring the alarm bells just yet," Travis Plunkett, legislative director for the Consumer Federation of America, tells Reuters today. "Over the last few years, especially since (the) September 11, 2001 (attacks on the United States), consumers have been more cautious in taking on new debt."
Indeed, as the Reuters story points out, the optimists can point to a recent Federal Reserve survey of the nation's largest 100 banks to offset the pessimism of the ABA report. The Fed data shows that the consumer card-delinquency rate was recently at just 3.7%, or slightly above a 10-year low.
Regardless of whether Joe's in over his head with credit card debt, there are other financial demons stalking our hero, courtesy of questions about the recent bull market in real estate. The question here is how much of Joe's penchant for spending is tied to the dramatic rise in the value of his house of late? A sharp correction in real estate prices could move such a question to the fore in a hurry.
No one knows what's coming, but we have some clues about what Joe thinks, courtesy of a new survey from RBC Capital Markets, which polled 1,001 consumers this month, reports The Wall Street Journal. Among the findings: homeowners think the value of their houses will keep rising. More than 70% of respondents predicted their homes would rise by more than 10% over the next three years. Meanwhile, more than half said the real estate bull market didn't affect their spending habits even though over 50% of respondents have tapped equity from their homes via refinancing, home-equity loans or lines of credit. But as the Journal article also points out, that response clashes with Federal Reserve Chairman Alan Greenspan's recent research, which warns that consumers have become dependent on borrowing against their homes to boost spending. If true, a rise in mortgage rates, which some predict, would threaten consumer spending.
We'll leave it to readers to decide if Joe's attitude constitutes a disconnect with the world at large. Meanwhile, in a sign of the times, mortgage lenders are tightening their credit standards and making it harder for consumers to take out real estate loans, reports the ContraCostaTimes.com (free registration required). The market will adjust, no matter what Joe thinks.
September 28, 2005
RESEARCH ROOM UPDATE
After adjusting for taxes, municipal bond yields should be comparable to Treasuries for similar maturities. Ok, so why aren't they? Taxes are commonly thought to be part of the answer, and for good reason. Munis are free of federal taxes and sometimes state and local taxes as well. Treasuries, on the other hand, are taxable on the federal level and exempt from state taxes. Calculating what the yields should be by factoring out taxes should leave similar yields after making the proper adjustments. But Mr. Market has often seen fit to ignore this academic rule of thumb. Why? In particular, why are tax-adjusted muni-bond yields higher than expected relative to U.S. Treasury Bonds? Good question, and a new research paper recently listed on the Federal Reserve's web site (and added to our Research Room today) claims to have some fresh insight on the muni yield conundrum, and by extension, what it means for investors.
September 27, 2005
BOTH SIDES NOW
The post-hurricane economic data is starting to roll in, and the conclusion is…less than conclusive. Or, perhaps we should say that one can find whatever one wants to find.
Economic forecasting isn't cloud gazing, although at times a lesser soul might be forgiven for confusing the two. Consider today's numerical releases: the Conference Board's consumer confidence index and Johnson Redbook Retail Sales Index. First the consumer confidence gauge, which crashed down to a reading of 86.6 for September from 105.5 in August. September's result is the lowest since October 2003, the Conference Board reports.
What explains such descending behavior for this measure of consumer expectations? “Hurricane Katrina, coupled with soaring gasoline prices and a less optimistic job outlook, has pushed consumer confidence to its lowest level in nearly two years and created a degree of uncertainty and concern about the short-term future,” says Lynn Franco, director of The Conference Board Consumer Research Center, in a press release.
Part of the sliding confidence was tied to the outlook for jobs, or the lack thereof. Only 14% of survey respondents said they expected more jobs to become available in the coming months, down from 16.4% a month ago. Meanwhile, those who expected fewer jobs represented 25% of responses in September, up from 17.3 percent in August.
After poring over the report's finer points, Scott Hoyt, senior economist at Economy.com, writes today: "The share of consumers planning to buy cars and appliances both dropped sharply, although the share planning to buy homes held steady." Worries that prices generally are headed higher were also reflected in the plunging consumer confidence index, he continues. "In a knee jerk reaction to soaring energy prices, the average expected rate of inflation over the next 12 months jumped to its highest level since at least the late 1980s."
Sounds fairly dismal, eh? Indeed it does. But Joe Sixpack and his friends seem strangely immune to the cautious reading that permeates the Conference Board's gauge. As evidence, consider today's release of the Johnson Redbook Retail Sales Index for the week ended Sept. 24, vs. Aug. 24. By that measure, retail sales advanced a healthy 2.9% for the month through last Saturday, reports TheStreet.com. Confidence among consumers may be declining, but spending continues moving in the opposite direction, which is to say, up. If this gauge has any relevance, perhaps the government's retail sales report for September, due for release on October 14, will show more spending strength than some expect.
But such continued spending doesn't convince everyone, starting with the bond market. The yield on the 10-year Teasury, at around 4.25% as we write this afternoon, is hardly shooting skyward in anticipation of continued consumer spending and/or higher inflation born of increased energy prices. The fixed-income set presumably thinks Joe has finally gotten in over his head, and will prefer to start saving his pennies in the very near future.
The thought has occurred outside of bond trading pits too. "We may now see a pullback in spending,'' Quincy Krosby, chief investment strategist for The Hartford in Hartford, Connecticut, tells Bloomberg News today. "This winter and this Christmas shopping season are going to be the test case, and we're going to see if this is the tipping point for the consumer."
September 26, 2005
MR. MARKET'S AGENDA
Hurricanes, volatile energy markets, and god knows what else haunt the stock market these days. But equities are holding up surprisingly well, considering that everything but the kitchen sink has been thrown at Mr. Market. The S&P 500, for instance, is now about 2.5% below its post-2000 peak set back in early August.
Does the market's resilience reflect optimism about future earnings? Certainly it's easy to be sanguine about the energy industry's capacity to refine greater earnings. As a Zacks report today reminds, the outlook for the sector continues to burn bright.
"As of late Friday, and ahead of Hurricane Rita hitting landfall, the energy sector was displaying the greatest aggregate strength in earnings estimates revisions," a Zacks commentary dated today advises. "Of the 25 highest ranked industries, seven are related to oil. The strong showing is not surprising given that energy firms are driving the positive revisions in full year S&P 500 earnings estimates."
Not surprising, perhaps, but neither is it universally accepted that the energy sector stands to gain the most when it comes to higher earnings expectations in the foreseeable future. Consider what Mr. Market does, as opposed to what the seers predict. On that score, the S&P 500's energy sector (one of ten that comprise the equity benchmark) remains in the bottom-half (number six out of ten, to be precise) ranked by Friday's market cap, according to data from Standard & Poor's. True, energy's relative market cap has moved up a notch from seven a year ago. But the financials sector has remained firmly in the number-one slot too.
In case you haven't noticed, companies that derive sales and profits from various financial activities have found the going a bit rougher of late. The ongoing elevation of interest rates, on the short-end at least, is one reason. With the gap between short and long rates continuing to shrink, the age-old game of borrowing short and lending long isn't quite what it used to be a year or two previous. For the moment, the change in the yield curve has hit hardest at the smaller, more leveraged financial operations, such as Annaly Mortgage Management, as we discussed last week. No wonder that industries such REIT mortgage trusts and finance leasing operations get relatively low investment rankings from Zacks at the moment.
Does that mean it's time to throw in the towel for big-cap financial companies? Mr. Market doesn't think so, or at least he's not saying so currently, to judge by relative ranking changes in the ten sectors that comprise the S&P 500. But Mr. Market isn't always known for his infallible to predict.
It's not as if the financials sector is only nominally in the lead when it comes to the market capitalization awarded by the collective decisions of investors. In fact, there's no contest, suggesting that the market sees nothing but clear skies for years to come in the likes of Citigroup, Charles Schwab, and Fannie Mae. Indeed, financials account for more than 20% of the S&P 500's $10.97 trillion market cap. The number-two sector, Information Technology, is a distant 15%, while number-six energy carries something close to insignificant at around 10%.
Energy, of course, isn't insignificant, as recent events suggest. Nonetheless, treating the sector as though it were in fact of relatively low consequence is a luxury that America can no longer afford. But exactly when that luxury ends is the question. On the matter of valuing stocks, luxury rolls on, one could argue. So too in the matter of building gasoline refineries for meeting the enduring rise in demand.
As always, distinguish between being right and making money. Sometimes the two go hand in hand, but very often one never meets the other. Mr. Market's agenda takes orders from no one.
September 23, 2005
WILL SHE, OR WON'T SHE?
Investors will have the weekend to ponder if Hurricane Rita will deliver the knock-out blow to the economy that Katrina threatened but never delivered. But some have already decided that the twin storms together won't be enough to derail U.S. GDP from its momentum. One research paper published this week even suggested that hurricanes actually boost economic growth.
Nonetheless, the American economy was slowing before Katrina, and the dynamic hurricane duo could exacerbate that trend, or so one could argue. Ed Yardeni, chief investment strategist with Oak Associates, for one, lowered real (inflation-adjusted) GDP estimates to 2% from 3%-to-4% for Q4 2005 and Q1 2006, courtesy of the recent weather. That ain't hay, as the saying goes. But neither is the downshift permanent, or so Yardeni forecasts. Writing today in an email to clients, Yardeni advises that by next year's second quarter "I foresee 3%-4% real GDP growth resuming." (If so, will that be evidence of hurricane's growth inducing powers?)
Yardeni's an optimist, at least by the standards of the latest forecast from the IMF, which projects U.S. GDP growth will touch just 3.3% for all of next year.
Does the bond market share Yardeni's optimism, or the IMF's more middling expectations? Hard to say, although by today's trading it appears the fixed income set is more inclined to keep a watchful eye over the weekend rather than make heavy bets one way or the other. The yield on the 10-year Treasury Note moved up slightly on the week, closing today's session at around 4.25%.
Might the bond market be struggling to come to terms with a fear of higher inflation on one hand, and a hurricane-driven slowdown on the other? Indeed, gold jumped to the $475-an-ounce level, marking an 18-year high. No less a force than the Federal Reserve seems inclined to take gold's view in that inflationary momentum, however moderate at the moment, could gather steam in 2006. Ergo, yet another interest rate hike this week by the central bank.
As David Gitlitz, chief economist with TrendMacrolytics, writes in a research note today, "The worst-case scenario for additional energy supply disruptions arising from Hurricane Rita also implied a worst-case inflation outlook resulting from the Fed accommodating
the consequent energy price spike, as seen in the gold price rallying to the $475 level."
But at the end of the day, a realist has to admit that rising energy costs cuts two ways. It's at once a force for slowing the economy (at least initially) and raising inflation. Correctly predicting which facet will dominate the other could be the secret for successful trading in the weeks and months ahead. Unfortunately, no one has a crystal ball. Opinions, of course, are passed around like beer at a picnic. That includes analysis today from JP Morgan global economist David Hensley, who tells Reuters:
"If we get another big ratchet up in fuel prices, then all bets are off -- not that we're forecasting recession but we're looking at the potential for a more severe slowdown in the U.S. economy. The more severe the slowing, the greater the possibility of ripple effects into the corporate sector. If corporates begin to scale back, then you're in a different ball game altogether. The stakes are pretty high here."
The stakes are high, and the outcome is still unknown. Monitoring Rita's impact on Texas, including its oil infrastructure, is job one at the moment. On that front, she's been downgraded to a category 3 storm earlier today. But such definitive analysis eludes the dismal science on gauging her impact. Yes, Virginia, it could be a long weekend.
September 22, 2005
FORECASTING FOR A RAINY DAY
The International Monetary Fund has published another global economic outlook, and the conclusion is nearly as optimistic as the previous forecast published earlier in the year. The IMF, in sum, says the expansion of world gross domestic product remains "on track."
On track here is defined as world GDP rising by 4.3% when all's said and done for 2005, and yet another 4.3% advance for 2006. That's down a bit from 2004's 5.1%, but up slightly from 2003's 4.0%, the IMF informs. That probably meets the average man on the street's definition of on track.
But behind the front-row optimism embedded in the prediction for continued growth in the world economy lies anxiety on the mismatch between savings and spending. To quote the IMF's spin on the subject:
"The U.S. current account deficit is now projected to rise to over 6 percent of GDP in 2005, 0.3 percent of GDP higher than projected in April, driven by higher oil prices and continued relatively strong domestic demand. On the surplus side, the key counterparts are Japan; China; the Middle East oil exporters, which as a result of soaring oil prices are now running a larger surplus in U.S. dollar terms than emerging Asia."
If this is supposed to frighten investors away from America, so far there's little sign of terror. As the IMF report observes, "capital inflow to the United States have remained strong, aided by robust private and official flows."
Perhaps the U.S. is still thought of as the only game in town--town being the global economy. China's up and coming, to be sure, and the European Community dreams of displacing America as the global powerhouse of first rank. But for the moment, capitalists the world over are willing to give Uncle Sam the benefit of the doubt when it comes to loaning the republic of record money.
Indeed, the yield on the 10-year Treasury remained more or less unchanged today at around 4.18%. If a yield could talk, what would this one be saying? Don't worry, be happy. Or, to be slightly more blunt, the path of least resistance for America is one of slowing economic growth, though possibly for exogenous reasons.
Hurricane Rita, in other words, may be threatening the Texas coast. "With Rita being a Category four storm it could slam into Texas oil refineries and drilling platform areas following Hurricane Katrina and its damage to refineries in Louisiana and that could have an extreme impact on U.S. economic growth," Paul Mendelsohn, chief investment strategist at Windham Financial Services, tells Reuters.
But didn't we hear the same in the first days after Katrina, a storm that was poised to force the Fed to pause, if not end its monetary tightening and send the economy into a tailspin? To be sure, if Rita inflicts serious damage on the Texas' oil infrastructure, the worst fears may yet come true for economic trouble. But the Fed's undaunted, or so its 11th hike in interest rates this week suggests. And what of all the debt the federal government is set to incur as the price tag of cleaning up Katrina's mess? Don’t' you know that such questions are yesterday's news? On to new and more timely tragedies.
So we now wait to see if Rita lives up to her billing as another monster. While we're waiting, it's worth pondering how far things have devolved for analysis of the American economic and financial scene when the weather determines the fate of the last remaining superpower. Yes, that's a reaction to the devastation and reach of recent storms. But at some point, fundamentals must resume dominance of informed analysis. But for the moment, there's only the weekend. Till then, the most important web site for traders remains NOAA.
September 21, 2005
WHAT'S UP WITH REITS?
In the coal mine, the demise of the canary sends an early warning sign that's something amiss in the atmosphere down under. Might REITs be the proverbial canary in the financial market warning that the investment air isn't quite fit to breath at current valuations?
To judge by one REIT of late there's certainly reason to ask if the much-discussed and, for some, much-anticipated correction in real estate and related securities has arrived in earnest. True, REITs have corrected several times previously in the 21st century, sometimes dramatically, only to recover and put a considerable amount of jam on the pessimists' faces. But how many lives does the REIT sector have?
In pondering that imponderable it slipped by no one who follows REITs that Annaly Mortgage Management last week collapsed its dividend to 13 cents from 36 cents. The news had the expected effect on the company's stock, which promptly dropped like a rock after the press release made the rounds.
The challenge for Annaly, and others who turn a profit from a positively sloped yield curve, is a world where borrowing short and lending long is fast going the way of the dodo and the SUV. Indeed, the latest installment of that reality came knocking again yesterday when the Federal Reserve raised short rates by 25 basis points for the 11th consecutive time while the 10-year Treasury yield barely budged.
Even before the latest hike in Fed funds, the writing has been on the wall, even at Annaly. "As students of our business model are aware, during the tightening phase of an interest rate cycle our cost of financing will rise faster than the yield on our assets," said Michael A.J. Farrell, chairman, CEO and President of Annaly explained to stunned shareholders last week.
Welcome to life in a financial universe dominated by a flattening yield curve. To be sure, the narrowing of the spread between long and short rates is no sudden development. But with Fed funds now at 3.75%, or less than 50 basis points below the 10-year Treasury (and less than 25 basis points below the five year Note!), the recognition that there's no traction in turning a profit from yield-curve plays is sinking in to Mr. Market's noggin.
There's a temptation to distinguish between mortgage REITs and those that focus on properties. Annaly, after all, is essentially a financial shop whereas property REITs own and manage offices, apartments, shopping centers, and so on. Two different worlds, right? Absolutely, with different business models to prove it. Nonetheless, property REITs generally aren't faring all that well these days either. The Dow Jones REIT Index, for example, fell again today, as it has for much of this month. The highs that REIT benchmarks were setting in the summer suddenly seem like ancient history.
Even if investors decide to return to REITs, as they've done time and time again in recent years after corrections, expectations about the sector may still be in need of an attitude adjustment. In turn, that suggests that heightened volatility in REIT prices may be par for the course from here on out. "It's harder for all of us to produce the numbers we were able to in the past," Michael Fascitelli, president of Vornado Realty Trust, tells Commercial Property News today. The sector's enjoyed strong growth in recent years, but as the history of corporate America suggests, maintaining growth rates becomes increasingly difficult as businesses grow. "People expect more," Fascitelli concludes.
Alas, investors may have to settle for less. REIT prices have been climbing for much of the 21st century. Even the stock market's undoing after the bursting of the tech bubble didn't derail the mighty REIT train. And for good reason, when everyone expected interest rates would continue to fall. The white knight was the world of REITs, which generally offer some of the highest equity yields in the marketplace. But yields just aren't what the used to be. Vornado, for instance, carries a 12-month trailing yield of around 3.5%, according to Bloomberg. As of yesterday, that's comfortably below Fed funds, and by extension, more than a few short-term debt instruments.
True, there are higher yielding REITs out there, including the 6%-plus on Equity Office Properties, the largest U.S. REIT. But the competition is rising. And as Annaly's latest announcement suggests, more dividend cuts may be coming.
September 20, 2005
So much for taking a hurricane break. The Federal Reserve today raised interest rates for the eleventh consecutive time, hiking Fed funds by 25 basis points to 3.75%.
Some analysts had speculated that the central bank would pause, if not stop its relentless drive to tighten monetary policy in response to Hurricane Katrina. And for a time, right after the images of a devastated New Orleans began hitting the airwaves, it seemed eminently reasonable that the central bank might take a breather, if for no other reason than out of sympathy. But as it turns out, Chairman Greenspan and his colleagues weren't intimidated by the weather, the graphic imagery, or anything else tied to Katrina. The Fed, in case you didn't realize, is all business al the time.
Yes, central bankers watch CNN, and recognized Katrina's tragic impact. "While these unfortunate developments have increased uncertainty about near-term economic performance, it is the Committee's view that they do not pose a more persistent threat," the Federal Open Market Committee advised.
If there's any hurricane legacy affecting Fed thinking it's one of raising inflation expectations by way of energy. With so much oil and natural gas production and distribution knocked off line because of the hurricane, energy prices have soared. That feeds directly into the inflationary pipeline, the Fed reasons. Again, from the FOMC statement today: "higher energy and other costs have the potential to add to inflation pressures."
The bond market seemed to buy the argument that the Fed should keep tightening so as to thwart an energy-driven jump in inflation. The yield on the 10-year Treasury Note was nearly unchanged today, closing the session at around 4.24%.
Why does the bond market like rising interest rates these days? For the moment, it's the preferred prescription to the current economic challenges. "If these inflationary considerations were not enough to stiffen the Fed's resolve to stick to its plans for future rate hikes, policymakers are also well aware that Katrina, like most natural disasters, will likely stimulate the economy," Milton Ezrati, senior economic strategist at Lord, Abbett & Co., told DowJones via SmartMoney before the central bank's rate announcement. Stimulate because rebuilding and government spending will filter out into the economy, putting money in contractors' pockets and some inflationary zest into the pricing pipeline.
News of yet another Fed funds hike was also celebrated by forex traders, who chased the greenback today. "The dollar is firming because the Fed is utterly unpersuaded that Katrina did any significant [economic] damage. Threats to growth are merely temporary," T.J. Marta, senior currency strategist with RBC Capital Markets in New York, tells Reuters today.
Whatever the economy has in store for the markets, there's no question that the gap keeps widening between U.S. rates and their equivalent in Europe. The 10-year Treasury now yields more than 100 basis points over its German equivalent, for instance. That's due in no small part to the European Central Bank's stubborn refusal to raise interest rates of late vs. a Fed that's intent on just the opposite. Then again, maybe the do-nothing monetary routine that's playing abroad is about to end, or so one could argue after European Central Bank President Jean-Claude Trichet's
But by some accounts America's longer-term economic health may depend on a lesser premium in U.S. rates relative to Europe. To the extent that higher relative interest rates boost the dollar, the stronger greenback makes American exports less alluring. That's just what the doctor didn't order, warns a new Levy Economics Institute research paper, The U.S. & Her Creditors: Can the Symbiosis Last?
A rise in exports relative to imports may be the only solution for what ails threatens the American economy, argues the Levy paper. “If the trade deficit does not improve, let alone if it gets worse,” the report warns, "there will be a large further deterioration in the US’s net foreign asset position so that, with interest rates rising, net income payments from abroad will at last turn negative and the deficit in the current account as a whole could reach at least 8.5 per cent of GDP.” Eight-percent-plus would represent uncharted territory in terms of high degree of red ink relative to the size of the U.S. economy. If that level of doubt found its way to these shares, it could arguably set off a chain of events that would be something less than advantageous from an investing perspective, such as higher interest rates to compensate for the risk. In turn, the higher rates would only exacerbate the trade deficit, and on and on.
That’s assuming the dire future comes to pass, as sketched out in this research. But using recent history as a guide, no one's made any money predicting that the trade deficit would reverse course. Will the future be any different?
Perhaps not, assuming the gold market harbors the truth about inflation expectations. The precious metal continues to hover near 17-year highs of late. If gold has any sway at the Fed, more interest rate hikes are coming, which means more support for the dollar and perhaps even deeper trade deficits.
September 19, 2005
A new age of higher energy prices may very well be dawning, but the United States isn’t going to rush into the new world order without a fight. Although the options available to the world’s last superpower are dwindling when it comes to keeping energy costs low, whatever does remain of America's choices won’t soon be surrendered.
West Virginia Gov. Joe Manchin is on the leading edge of a new political movement intent on limiting the pain thrown off by the current bull market in gasoline. It's not much, mind you. But it's the spirit that counts. The Pittsburg Post-Gazette reported yesterday that the governor has promised to sign an executive order that rescinds a previously planned 1.5-cents-a-gallon gasoline tax, which would otherwise add to the current 27-cent-a-gallon tax.
West Virginia’s governor is hardly alone in eyeing opportunities to pare back gasoline taxes of another sort--i.e., the one enacted by Mr. Market. As the New York Times noted yesterday, lawmakers in more than a dozen states plus the District of Columbia are considering plans to reduce if not cancel state gasoline taxes. "This issue has very much taken off," Arturo Perez, of the National Conference of State Legislators, tells the Times.
High gasoline prices are usually motivation enough for politicians to seek ways to help Joe Sixpack keep the cost of driving as low as possible. But just in case that doesn’t suffice in the 21st century, some politicians are further stoking the fires by putting oil companies in the crosshairs. Every cause tied to energy needs a villain, or so history suggests, and the time-tested target of Big Oil remains a favorite bulls-eye. Gov. Christine Gregoire of Washington, for instance, said that "oil barons are making $200 million a day in profits,” The Columbian reports. The amount of profits are excessive in the eyes of the Evergreen State’s chief executive, who says that "there is absolutely no reason for gas to go up in Washington as the result of a hurricane." No word yet on whether she’s pushing for the development of a new oil refinery in her state as a potential source of lowering gas prices.
In any case, there are easier, faster ways to lessen the cost of driving, or so the political system reminds. Accordingly, Washington State voters will be asked in November to vote up or down on Initiative 912, which would repeal a 9.5-cent-a-gallon gasoline tax in the state. In dollars and cents, this is clearly one way to reduce the cost of fuel. Yet it does nothing to boost supply or promote conservation. But economics, strategic thinking, and politics don’t always mix, at least not in obvious ways.
Moving right along, minds can and do differ as to whether denial is set to become part of the American landscape on the matter of energy policy. And while we’re at it, one can debate if denial has been present in the past in the country’s various efforts to find solace in the increasingly turbulent nexus of economics, politics and energy.
In any case, there’s a fine line between serving the public interest by keeping energy costs as low as possible and allowing a price incentive to endure so as to promote the development of alternative energies. Finding common ground on that fine line promises to be one of the more challenging political debates facing America in the months and years ahead, and one whose stakes are high.
It’s obvious to everyone that the U.S. imposes relatively low gasoline taxes compared to Europe, where $4-a-gallon prices-plus have long been common vs. below $2-a-gallon (until recently) in America. Assuming the market will effectively impose European-level taxes on drivers in the U.S. going forward, the question then becomes: Is that a healthy step for transitioning to a post-oil age? Or, as some argue, are hefty gasoline taxes (regardless of whether driven by government or the marketplace) detrimental to economic growth?
It’s easy to point to Europe’s comparatively anemic rate of expansion in GDP and conclude that high gas taxes are anti growth. And indeed there’s truth in them ‘thar economic hills. Paying more for energy leaves less disposable income for big-screen TVs, IPods, and the like. That’s hardly encouraging for the consumer paradise of America. But is it fatal?
It's just as easy to argue that America's relatively low energy costs don’t go far enough to promote conservation and a post-oil economy.
Perhaps there’s a way to compromise and inspire consumers to favor alternative energy without killing the golden economic goose in the process. Or is such thinking hopelessly naïve? If such a compromise exists, it almost surely involves tinkering with the pricing of energy. Then again, how about letting Mr. Market set the tone by way of letting supply and demand determine the price of energy. Yes, such a worldview receives plenty of lip service, until a bull market blows into town and triggers a political reassessment.
Meanwhile, it’s all null and void if the bull market in energy is set to collapse. Why think strategically if the price of oil’s falling?
Alas, the market doesn’t look all that cooperative these days. Oil prices jumped sharply today on mixed news about Opec’s commitment to pumping more crude in the foreseeable future. The silver bullet in energy remains elusive. Meantime, perhaps it’s time to scare up a few more rounds of reversing gasoline taxes.
September 16, 2005
THE GOLD RUSH OF '05
When in doubt, buy gold. That seems to be the informed, or at least inspired decision of the moment. The precious metal today danced about $460 an ounce--the highest since 1988. Year to date, gold's up 4.6%, making it one of the better performers among asset classes (assuming you think of gold as a separate asset class, which some clearly do).
What's driving gold higher? The same age-old fear that's been behind most price surges in the precious metal: the fear that the paper alternative of money will be less than the government promises in the years ahead.
Speaking of promises, there were some big ones last night when President Bush pledged to spend heaps of money to rebuild the Gulf Coast economies devastated by Hurricane Katrina. "Federal funds will cover the great majority of the costs of repairing public infrastructure in the disaster zone, from roads and bridges to schools and water systems," he said, via CNN.
The Economist, reacting to the speech, observes that the President "seems to have turned…into something resembling a big-government Democrat." That's a thinly veiled reference to a President who's not shy about opening the government's coffers. That, in turn, inspires the gold bugs to buy up more of their precious metal on the belief that government spending for Katrina, Iraq, and all the rest will push inflation higher.
Adding high energy prices to mix is said by some to add up to the perfect inflationary storm. There's something to this. As we've written in recent days, the inflationary effects of elevated oil and gasoline prices are a clear and present danger for consumer and wholesale prices. Gold traders think no less. Yes, some hold out the hope that energy prices will eventually retreat. But so far, that hope's proven elusive. "People are also starting to worry about the inflationary impact of the higher oil price and that is putting the focus on gold again,'' Sandy McGregor, director of Allan Gray Ltd., South Africa's largest privately owned money manager, tells Bloomberg News today. In the same story, James Moore, an analyst at BullionDesk.com, observes that all the gold buying of late is inflationary hedging. "Most people in the market won't have seen prices this high. All the ingredients are right for gold to move higher.''
Some analysts are now looking at the $500 mark for gold prices, saying the recent momentum will carry the metal there in the foreseeable future. "Gold is really looking good now and seems to have a clear upside objective," Mark Keenan, fund manager at UK-based MPC Commodity Fund, tells Reuters.
Support for such thinking comes anew from the bond market, where the yield on the 10-year Treasury Note continues to rise, settling in today's session at 4.26%, the highest in a month. Meanwhile, the latest bout of inflation jitters gives new incentive for the gold bugs to pronounce once again that the economic chickens are coming home to roost. Consider today's missive from Euro Pacific Capital's Peter Schiff, who argues that the metal's price surge of late is a warning sign of no trivial import. "As the price of gold tends to rise in inflationary periods, economists should ask themselves if they believe the government or gold. History and recent anecdotal evidence certainly favor gold."
Whatever comes, today's news on what Joe Sixpack is thinking throw cold water in the face of the economic optimists. The University of Michigan's mid-month report on consumer sentiment for September dropped like a rock from August. No surprise, perhaps, given the fallout from Katrina. But repairing Joe's outlook may be no less important than repairing the damaged infrastructure in the Gulf region.
But Joe's loaded up with debt, and looking at higher costs tied to energy. Can he be inspired to keep spending? To keep America's "bubble economy" going, as Schiff puts it, "politicians must keep consumers borrowing and spending. By transferring wealth from creditors to debtors, inflation helps make this possible." That'll play right into the hands of the gold bugs. Maintaining fiscal and monetary sanity, on the other hand, may finally convince Joe to steer clear of the malls.
The proverbial rock and the hard place once again promise to be a topic of discussion in the coming week.
September 15, 2005
Joe Sixpack's sensitive to fuel prices after all. Or so one could argue given the latest batch of gasoline data from the Energy Information Administration. The most-recent weekly average for demand, through September 9, fell to 8.636 million barrels of gasoline a day. That's down more than 4% from 9.027 million b/d in the previous week. The drop's even steeper from the 9.406 million b/d of two weeks ago. Is this a sign that higher prices have triggered a new era of conservation-minded Americans when it comes to fuel? Or is the recent data an anomaly and/or a cyclical glitch tied to the end of the traditional driving season?
The answer, as the New York Times today suggests, is less than definitive at the moment. Declining demand for gasoline "may also be explained by disruptions in the nation's energy supply system, which is still recovering from Hurricane Katrina," the Times notes. In addition, EIA numbers for gasoline demand generally are less than perfect in measuring exactly how much Joe buys when he drives into the local gas station. Again, from the Times: EIA estimates "do not measure every drop of fuel that drivers put in their tanks, because the agency can track gasoline only until it is delivered to large regional terminals, where it is then trucked to wholesalers and retailers, said Larry Alverson, an analyst at [EIA]."
John Kilduff, an oil analyst at Fimat USA in New York, weighs in with an observation in Reuters via USA Today: "Demand was down nationwide, partly because drivers were off the road in parts of Louisiana and Mississippi because of Katrina, and obviously because high prices are helping to discourage demand."
Demand can be discouraged for a number of reasons, and when demand slips, all's not necessarily well elsewhere. The driving public has, until recently, been more than willing to keep filling their SUV tanks in the face of rising gasoline prices. It's a driving culture, in case you didn't notice. But when prices spiked at the end of August and early September, courtesy of Katrina, even Joe and his buddies were chagrined and shocked at how much they were paying to fill up their four wheelers. Gasoline prices have since retreated, giving our hero a bit of a break, although prices have only fallen back to pre-Katrina levels, which is to say the remain historically high.
Katrina's toll is now filtering through to more than just energy prices. Initial jobless claims soared to 398,000 for the week through September 10, up 25% from the week previous, the Labor Department reports. Virtually all of it is due to the hurricane. In fact, the jobless claims number was probably higher than reported given that many of the unemployed may be sitting in shelters or trying to solve more pressing concerns, such as finding a lost loved one, rather than filing for unemployment.
All of which surprises no one who reads the news. But how long will the bell toll for the economy as it relates to Katrina's aftershocks?
Lower gasoline demand and higher jobless claims are but two shoes dropping in the aftermath of the Gulf region's destruction. Other economic footwear is sure to descend. But all's not lost, at least when looking at the stock market's reaction, which is surprisingly upbeat so far. Since August 30, when the S&P 500 closed at its lowest since early July, the index has climbed 1.6% on a price basis through today's close.
Donald Luskin, chief investment officer at TrendMacrolytics, writes in a note to clients today that the equity market is doing surprisingly well compared with other large-scale disasters in the past. One reason may be, as Luskin writes, that the "pro-growth policy [in the U.S.] is still on track." He goes on to explain, "On the policy risk front, we are still betting that the $70 billion in tax cuts over five years built into Congress's budget reconciliation process will be accomplished. This would include a two-year extension of the 2003 reductions in tax rates on dividends and capital gains (extending their sunset from 2008 to 2010), the extension of expensing provisions for small business, and the extension of the Alternative Minimum Tax 'patch.' "
Perhaps the prospect of continued growth scares the bond market. Or is it the threat of higher inflation in the post-Katrina world? Or both? No matter, the fixed-income set is no mood these days to see the glass half full. The yield on the benchmark 10-year Treasury moved above 4.2% today for the first time since mid-August.
All of which leads back the tired old question of whether Joe Sixpack will stop spending. Apparently, he's willing to cut back on gasoline. Is his new mindset temporary, or the just the first embrace of a new world order of fiscal caution? Joe's not saying much, at least not yet, but everyone's wondering. As Ed Yardeni, chief investment strategist at Oak Associates, writes today in his morning briefing to clients: the question about the consumer going forward has been front and center in his discussions. "Most money managers I talked with are nervous." Still, Yardeni's upbeat, predicting that Joe will keep going to the malls. The reason? It's what all the optimists say these days: real (inflation adjusted) pay per worker is expected to grow.
Unfortunately, waiting for post-Katrina confirmation, either pro or con, will take time. August personal income and spending numbers don't come out till the end of the month. But those numbers are still pre-hurricane. That puts the all-important September gauge on that front more than a month away. Meantime, hope, fear, and everything in between spring eternal.
September 14, 2005
LOOKING FOR MR. DOOMSDAY
It wasn't supposed to matter, thanks to Katrina. But today's retail sales report for August may be relevant after all, despite the fact that the report is a snapshot of consumer habits for the weeks leading up to the hurricane's attack on New Orleans and the surround region. Yes, it's hard to ignore the 2.1% drop, the biggest monthly decline in retail sales in nearly four years. Or is it?
Economists aren't necessarily disturbed by today's report for retail sales, in part because for the year through August retail sales are still up 7.9%, or more than twice the rate of the latest report o the economy's growth. "These results [for August's retail sales] cast more cold water on the notion that if nondiscretionary spending on energy swells, it must crimp discretionary spending. It hasn't," says Ken Mayland, chief economist for ClearView Economics, in an interview today with Marketwatch.com "Consumer spending has continued to advance strongly" despite the jump in energy prices in recent years, he observes.
Waiting for Joe Sixpack to crack and cut his credit cards into shreds will have to wait a bit longer. Meanwhile, it's a thankless pessimism in that it's been more than a little unsatisfactory over the years in delivering the fatal blow that some say is forever imminent. But if betting against the primary engine of the U.S. economy has been a losing proposition, fear still springs eternal. The current source of that fear, for those who choose to subscribe, is the belief that once the post-Katrina numbers start rolling in--September's retail sales, for instance--spending will be shown to be in retreat.
And indeed it may prove to be. But if so, that's not the end of the world, nor necessarily the start of a recession, argues one dismal scientist. "In general, the economy is proving to be resilient to energy and gas price pressure. It's on a growth path," Michael Englund, chief economist with Action Economics, tells CNN/Money. "Even though oil prices are higher, the fundamentals of the economy are strong. Therefore, we see consumers' savings rate falling and spending up."
To be sure, Katrina's effect will be seen in the not-so-distant future. The question is, to what degree? Minimal, predicts another obsever of the economic scene. The economy expanded by 3.3% in the second quarter. Assuming that holds, it would be trimmed to roughly 3.1%, courtesy of Katrina, says Michael Cosgrove, an economist at the Dallas-based consultancy Econoclast, in an interview this morning with CS. The Katrina effects could last through the remainder of 2005, he notes. But while the economy may be facing another "modest" slowdown, "it's nothing to get overly concerned about," he counsels.
Yes, consumers are overextended, Cosgrove admits, but it's far from the first time that Joe Sixpack's found himself in that position. "The consumer's probably at the point in the economic cycle where his spending slows relative to GDP," he advises. So why isn't Cosgrove worried about recession? It comes down to the fact that if job growth holds up, which he expects, that will convince the consumer to keep spending, albeit at slower pace, he reasons.
The combination of Fed interest rate hikes, high energy costs, and Katrina will almost certainly bit the economy, Cosgrove continues. In turn, the Fed will probably stop hiking rates. In addition, he thinks the forces of disinflation will prevail. Overall, the post-Katrina rebuilding phase will kick in during the weeks and months ahead. That means that there will be a burst of spending and job creation tied to the recovery projects. In addition, a resumption of gasoline production from the Gulf region to something approaching normal could help reduce fuel prices. All of which could go a long way in making 2006 another year of economic growth. Yes, next year's GDP growth could fall to the 2.8-3.0% range, Cosgrove concedes. But an economic doomsday's nowhere in sight, he forecasts. That is, until the next economic report.
September 13, 2005
RESEARCH ROOM UPDATE
Can a central bank's monetary policy serve two masters? That's more than an academic question for the United States. The dollar is the world's reserve currency as well as the domestic medium of exchange. As a result, the Federal Reserve is charged with making monetary decisions that, in a perfect world, serve both local and international objectives at once. Can both be done without compromise? Or is there an inherent conflict of interest in the two? Not to worry, writes William Gavin, vice president and economist at the St. Louis Fed, in a new essay that today becomes the latest addition to our Research Room. Fear not: a central bank can manage its currency for the benefit of its citizens and the global economy without doing injustice to either. The device that lets the Fed burn the monetary candle at both ends is inflation targeting, or so Gavin explains.
September 12, 2005
IT'S STILL ALL ABOUT OIL
At least Katrina's dark legacy will eventually fade. Energy is another matter for the simple reason that the bull market in oil may still have legs. If more of the same is coming in the pricing of crude, the trend will eventually squeeze the economy to a degree that's more noticeable, and for the worse.
That starts with inflation. Higher oil prices stoke higher inflation. That's a byproduct of the fact that oil is directly or indirectly tied in varying degrees to much of what America produces in goods and services. It's also a key cost in transporting goods, not to mention people. Oil's also a component in the manufacture of items that you wouldn't immediately connect with energy. Indeed, petroleum-based products can be found in a range of items from medicines to plastics.
Accordingly, businesses have a hard to avoid getting hit with the higher cost of operation when oil prices rise. Business people, being an intelligent and logical race of creature, try to pass any additional costs on to consumers, thereby laying the groundwork for higher prices generally. The key here is that the higher prices aren't driven by higher demand; rather, the higher prices are a function of the bull market in energy. Translation: inflation can find fertile ground in the latter form of price hikes.
It's happened before (as a quick review of the 1970s will confirm), and it may be happening again, albeit in a nascent state. So far, at least, we're a long way off from the inflationary fires that burned in the seventies. But raging infernos can start with a single match. To be sure, there are both inflationary and deflationary forces blowing in the global economy. Deciding which one will triumph over time is at once pressing and difficult. But one will eventually win, and perhaps sooner rather than later.
In that task of diving the future, doomed or not, we can start by looking at the past. The nature of the current inflation, such as it is, appears to be driven by energy. Consider the producer price index. Measured sans food and energy, PPI's year-over-year advance in July was 2.8%. Add food and energy back into the mix and the annual rise jumps to 4.6%. A similar trend is visible in consumer prices: CPI ex-food and energy increased 2.1% on the year through July vs. 3.2% when the index is calculated with food and energy prices.
Is more of the same on tap for tomorrow, September 13, when the August CPI and PPI numbers are released? Absolutely, or so the consensus forecast suggests. PPI for August (scheduled for release tomorrow, September 13) is expected to rise 0.7%, while PPI ex-food and energy will advance by just 0.1%, according to estimates compiled by Briefing.com.
The fact that energy is the force pushing inflation higher is both a blessing and a curse. A blessing in that we know where the inflationary momentum lies. As such, we can surmise that inflation may yet be contained if energy prices fall. If energy is the reason for inflation's ascendancy, energy can also be its slayer, if oil prices retreat. Today, at least, there was reason to hope for such an outcome. A barrel of crude fell 1.2% today in New York futures trading, closing at around $63.3, the lowest in nearly a month.
But one day a trend doesn't make. As news of the Gulf of Mexico's rebuilding gathers attention, the opportunity for a near-term pullback in energy prices looks promising. As traders cash in on the recent price surge tied to Hurricane Katrina, there's reason to think that renewed efforts to boost supply by any means possible could affect short-term sentiment.
In turn, a sustained fall in oil prices could soon pare the inflation rate. Then again, so too could an economic slowdown. Indeed, today's sharp drop in oil prices is said by some to reflect a downshifting in the U.S. economy. "For the first time, traders have to worry about demand," Gary Ross, chief executive of U.S. energy consultancy PIRA Energy, tells Reuters today. "There's no doubt there is evidence of demand destruction emerging everywhere. U.S. gasoline data over the next few weeks will show the effect of high oil prices on demand."
Thorsten Fischer, senior economist at Economy.com, tells TheStreet.com advances a similar notion, predicting that "there will be a reduction in economic activity in the second half of this year, in part because of high energy prices."
But once again, there's a spirited debate on the issue. The gold market, for one, begs to differ, or so one could argue. The price of the precious metal forged higher for a time again today, pushing north of $450 an ounce for the first time since last December. "Rising energy prices raise concern over inflation, which will drive gold prices higher as investors buy the metal as an anti-inflationary hedge,'' James Moore, a metals analyst at TheBullionDesk.com, tells Bloomberg News today.
The markets will eventually have to sort out whether high oil prices promote inflation or recession. It can't be both.
Meanwhile, the yield on the 10-year Treasury Note rose to about 4.18% in sympathy with gold. That's the highest yield since August 26, a few days before Katrina hit the Gulf coast. Bond traders are worried that with oil prices falling, the Fed may feel less political pressure, born of Katrina, to halt its recent round of interest-rate hikes, which may be inflationary if, as some assert, the Fed's monetary policy is still too loose.
There are as many theories about where interest rates, gold, inflation, and the economy are headed as there are traders on Wall Street. But no matter your view of the global economy, and the rules that govern it, energy may still be the closest thing to an advance notice on what lies ahead for those markets. Now if we could just figure out where the price of oil is headed, and what the price change means, we could pick the winners and losers with absolute precision. Meantime, until value rears its pretty little head, speculating is the only game in town. Step right up and place your bets!
September 9, 2005
FOLLOW THE MONEY
Gold touched a nine-month high this week. Is this a sign that inflationary fears are again moving to the fore? Perhaps, although news of gold's improving allure from a fashion perspective may have something to do with the latest leg in the metal's bull market.
The public's appetite for things golden has reached a record high, according to the metal's trade group. "Consumer demand for gold jewellery has rocketed to over 2,600 tons," the World Gold Council (WGC) reports. "The 12 months to June display a surge in the popularity of gold and the past nine months have seen double-figure gold consumption growth." Much of the demand surge comes from India, China, and the Middle East. Meanwhile, "jewellers have been stocking up on gold ahead of the Indian festival season and investors have also been flocking to the market," WGC also notes.
Worries of higher inflation may be secondary, but secondary doesn't mean forgotten. As the WGC observes, "investors are taking a keen interest in gold due to speculation that the U.S. will not raise interest rates in the aftermath of hurricane Katrina."
Indeed, courtesy of Hurricane Katrina, the prospect that the Fed may pull the plug on the rate hikes that began over a year ago is becoming the talk of Wall Street. What's more, some say there's a chance that the Fed may embark on a fresh round of lowering rates. Such talk is gaining the attention of even the bond bulls. For example, in an interview today with CS, Van Hoisington, who manages $4.5 billion of Treasury bond portfolios at his ownHoisington Management, says: "If the Fed began to ease aggressively over the next 12 months we'd become very nervous. But we don't know, so we have to wait and see."
The first warning flag that the central bank is rethinking its tightening policy would likely be an acceleration in the growth rate of the M-2 money supply, says Hoisington, who manages the Wasatch-Hoisington U.S. Treasury Fund, which Morningstar gives high marks to as a long-term performer in its class. Last year, M-2 expanded by 4.5%, well below the long-term average of 6.7%, he advises. In the last six months, M-2's pace of change continues slowing, down to 2.5%. But if the pace of money creation starts to move higher to any degree, implying lower interest rates, Hoisington says he may reduce the 20-plus-year average maturity in his Treasury portfolio in anticipation of higher inflation down the road.
Why would a bond manager fear a Fed that's no longer tightening the money supply? Because in the long run, which is Hoisington's investment horizon, higher short rates suggest a slowing economy and lower inflation, both of which promote higher prices for bonds, he explains. As such, he concludes that if the Fed is willing to stop raising short rates, inflationary worries will return, taking a toll on long-dated fixed-income securities.
Nipping inflation in the bud may not be the high priority at the moment, however. Katrina has reordered Washington politics. Indeed, the hurricane claimed its first political casualty today with news that Federal Emergency Management Agency chief Michael Brown was taken off the Gulf Coast operations and recalled to Washington, Reuters reports. Is the current monetary policy slated to be the next casualty?
Yes, inflation may be a lesser threat these days, but the potential for something more still lurks. Consider today's import price report for August from the Labor Department: for year through last month, import prices jumped 7.6%. Although that's down about from the highs of around 10% last year, it's still lofty enough to suggest that America's appetite for imports could be a recipe for raising inflation. Indeed, import prices on a yearly basis are running about twice as high as domestic inflation rates, as measured by consumer prices.
Perhaps it's time to resurrect a favorite spectator sport from the Volcker-era by paying closer attention to the Fed's Thursday updates on money supply.
September 8, 2005
SIGNS OF THE TIMES
You can see a lot just by looking, Yogi Berra once advised. True for baseball, true for the stock market, where the 10 sectors that comprise the S&P 500 are dispensing signals about investor sentiment.
Much has been made of the stock market's resilience in the face Hurricane Katrina's wrath, and price tag. Ill-informed or not, the S&P 500's bounce off of the recent low of August 30 has impressed some observers of the investing scene. Indeed, all ten sectors show gains so far in September. On a year-to-date basis, however, the stock market is a divided realm.
Let's start with the winners based on 2005 performance through September 7: energy, consumer staples, healthcare, and utilities. Now compare that to sectors with year-to-date losses: materials, industrials, consumer discretionary, financials, and information technology. Notice a trend? Mr. Market's placing his bullish bets on energy and commodities, and the traditionally defensive sectors of consumer staples and healthcare. The selling's concentrated on groups that normally do well in periods of robust economic growth.
Is this what a bull market looks like? Perhaps not. Consider that in 2003, a year when the price of the S&P 500 jumped 26.4%, all ten sectors showed handsome gains on the year too. History repeated itself in 2004, when the S&P's price rose a more-modest but still-respectable 9.0%. Once again, all ten sectors followed suit in 2004 with gains.
All of which contrasts with the mixed year-to-date results for the ten sectors in 2005. Is this a sign of behind-scenes-stress in the S&P 500?
It's easy to be anxious these days, in no small part because of energy. "There is no doubt that this is going to be a very tough winter season for the American economy (and) for American homeowners," U.S. Energy Secretary Sam Bodman said today in an interview on the "Fox & Friends" television news program, Reuters reports. That comes a day after the Energy Department warned that natural-gas heating bills could climb more than 70% for some part of the country, the news service added.
We don't claim to have a crystal ball, but we can still ask questions, including this one: Does all this sound like the backdrop for sparking the next broad-based bull market in stocks?
September 7, 2005
ON A CLEAR DAY (YOU CAN SEE FOREVER)
Some say it'll cost $50 billion. Others predict $100 billion. Senate Minority Leader Harry Reid (D-Nevada) goes as far as to predict it will be $150 billion. Whatever the final price tag for federal spending tied to Hurricane Katrina, the impact on the U.S. budget threatens to be more than trivial. The bond market seems to be preparing for no less. The benchmark 10-year Treasury Note's yield continued rising today, closing the trading session at 4.14%, the highest since August 29.
Contributing to debt traders' new-found anxieties are fears that the federal budget deficit, officially forecast before Katrina to be $331 billion for the fiscal year ending September 30, 2005, according to an August 15 report issued by the Congressional Budget Office. For FY 2006, the deficit would retreat to $314 billion. Or so the pre-Katrina outlook advised.
The government's red ink projections look a bit different now, courtesy of Katrina because of spending. The $10.5 billion relief bill enacted last week is merely the first of what's expected to be several more spending packages tied to the hurricane's devastation. "Hurricane Katrina will be by far the costliest disaster in United States history, requiring $150 billion to $200 billion in relief, clean-up and reconstruction spending by the federal government, and causing the short-term loss of some 400,000 jobs," reports The Independent.
Responding to Katrina's victims "has become our major priority," Senate Majority Leader Bill Frist (R-Tennessee) said yesterday. That was more than just idle chatter. Frist reportedly delayed a vote on ending the inheritance tax, for instance, which many Republicans have previously said was a priority in reforming the tax system, according to Newsday.
Yet the CBO suggests that not all's lost, at least relative to what passed for fiscal rectitude in Washington before the hurricane arrived. The best guess at the moment, according to a CBO study published September 6, says that Katrina economic impact "will be significant but not overwhelming." Specifically, there's the "potential to reduce growth by between one-half and one percentage point at an annual rate in the second half of 2005," the CBO warns. Putting that in context, CBO is projecting 3.7% real growth in 2005 and
3.4% in 2006. In fact, the CBO gushes, the impact on a year-to-year basis may even turn out to be as small as a few tenths of a percent of GDP.
But true to form of late in bond land, things are more complicated than they appear when viewed through a trader's prism. The Katrina effect has convinced a growing number of investors that the Fed will stop raising interest rates sooner rather than later. That includes PIMCO's Bill Gross, who runs the largest bond fund on the planet. His guess is that the Fed will stop raising rates sometime next year, with Fed funds topping out at 4.0%, or 50 basis points above the current rate.
An end to rate hikes should be good news for bonds. So why all the selling? Analysis by Gross lends a clue. As he writes in his latest missive, it's time to "cut the fat" from fixed-income portfolios. "If the home asset bubble stops expanding, deflates, or pops any time soon (and I suspect we are only a few short months from at least the first of these three) then the potential for Greenspan’s 'debt liquidation' follow-on is something that investors must begin to prepare for," he warns. "Debt liquidation, as opposed to loan growth, slows an economy or sinks it into recession, generating the higher risk premiums that the [Fed] chairman warns us lie ahead."
Does this mean it's time to dump bonds? Perhaps, perhaps not. Even Gross is less than crystal clear on what his own forecast means. "A bullish orientation towards the front-end of the curve therefore should begin to dominate bond strategies," he opines. "That is not to say that long government bonds won’t go up in price if the 'system' suffers some elimination, slower growth, or to be frank, a recession in 2006. It’s just to acknowledge that the better duration-weighted paper lies at the front-end of the curve, especially now that it provides similar yields to longer maturities."
The post-Katrina world is unfolding fast, but that doesn't mean that clarity's just around the corner.
September 6, 2005
AUTUMN'S GREAT DEBATE
The post-summer trading season began today with a bit of dissent over what will, or won't happen as an economic consequence of Hurricane Katrina. The stock market cast its vote about the morrow in clear terms with the S&P 500 surging 1.3% from Friday's close. The bond market, by contrast, retreated slightly, pushing the yield on the 10-year Treasury up a touch to around 4.08%.
The opposing outlooks that often characterize equities and debt were on display today, and the immediate cause arguably is the pullback in energy prices. Crude oil futures in New York closed the session at a few pennies under $66, the lowest since August 23. Gasoline futures also continued tumbling, falling 6% on the day and shaving prices back to levels last seen on August 26.
Is the equity market merely relieved at the decline of energy prices, or is there something more fundamental to be had in the news of the day? One reason for optimism is the belief that the rebuilding in the wake of Katrina will more than offset the storm-related economic losses. From that narrow perspective, the optimists found reason to bid up stock prices. In fact, as one reviews the recent history of natural disasters in the U.S., the lesson is usually that the economy rebounds. As Edward Lotterman, a columnist at Knight Ridder, today writes via the News-Sentinel: "…it is important to remember that such natural disasters [as Katrina] destroy wealth but usually spur production of goods and services."
Of course, that's no guarantee that the shock of Katrina won't trigger an economic slowdown this time. The magnitude of the disaster, along with the sentiment shock that may yet be broadcast around the nation, is not your garden-variety hurricane ordeal.
Getting a handle on what could go wrong, or right is a challenge as well. This was, and remains, a multi-faceted tragedy. But if there's one gauge of what's coming, it may very well lie with energy prices. So far, it's too early to tell what oil and gas will do. That's partly because the effects born of releasing oil from the Strategic Petroleum Reserve, and a similar stockpile in Europe, are still calming anxious energy traders. The longer term path of energy prices is still an open question, however, and on that score there's reason to remain cautious. Indeed, the SPR is at best a short-term solution that's measured in days.
As for the bigger picture, the immediate challenge remains in the Gulf of Mexico region, where roughly 10% of America's refining capacity, or what's left of it, resides. To be sure, U.S. oil production in the Gulf has recovered to nearly 70% of its pre-Katrina production, reports the Financial Times. How soon it gets to 100% will cast no small influence on energy markets, and therefore the public's sentiment as to taking yet another stroll down to Wal-Mart to buy a new wardrobe, microwave oven, or food processor that doubles as a telephone. We know that Joe Sixpack was already spending like a drunken sailor, as the personal saving rate was negative in July for only the second time since the Great Depression (the other time being October 2001), relates The Washington Times. We can only guess what impact Katrina will have on such profligacy, although we can guess.
In the meantime, more politicians are anticipating a bull market in energy prices. Utah is the latest state to consider putting a cap on gasoline, according to the Deseret Morning News. Apparently not everyone shares the stock market's optimism today that the worst has past when it comes to energy. Or, is that just politics run amuck after the fact?
Regardless, it's not hard to find optimism on the larger question of whether there will or won't be a recession after the current mess in the Southeast is cleaned up, the babies fed, the elderly cared for, and the dead buried. To be sure, economic growth will take a hit, but it won't be fatal, assures the Christian Science Monitor. Katrina will trim GDP by 50 basis points in the second half of 2005, writes CS staff writer Mark Trumbull. "Then, the economy could get a Katrina stimulus, as rebuilding gets under way in earnest early in the new year."
Perhaps, but forecasting remains an imperfect science, sunny skies or not. Compounding the usual challenge in prognosticating in the dismal science is the fact that Katrina is "an unprecedented event," says Economy.com's Robert Dye, who's quoted in Trumbull's article. Accordingly, there's a certain degree of mystery and then some as to how the economy bounces back from the latest turmoil.
That didn't stop equity investors from chasing hope today. Indeed, among the S&P 500 sector ETFs, consumer discretionary (Amex: XLY) led the party today, with shares jumping 1.6% vs. 1.4% for the S&P overall. Stuffed with the likes of Home Depot, Time Warner and Target, the rally in the ETF reflects the hope that all's well now that the rebuilding in New Orleans and surrounding areas is set to begin in earnest.
Still, with the collective sigh still echoing on Wall Street it's timely to remember that there were a few threats nipping at the stock market's heels before the weather-induced trauma arrived. The economy may in fact face decent odds of dodging catastrophe born of Katrina, but even that would mean that the markets in short order will again be looking at the same old set of challenges. Regardless, clues about the future, for good or ill, are embedded in the energy markets. Keep your eye on those near-term futures contracts.
September 2, 2005
THE LADY IS A TRAMP
Will she or won't she? That's the question. The answer will be forthcoming. Meantime, there's the debate, speculation and outright guessing about whether Hurricane Katrina is the straw that pushes the economy into recession.
As usual, the bond market is the front line in such debates. The benchmark 10-year Treasury Note's yield has fallen in recent days, suggesting that the risk of an economic slowdown has risen in Katrina's wake of devastation. The 10-year's yield ended today's session roughly unchanged from Thursday, at just over 4.0%. That's down 20 basis points from a week ago, and about 40 basis points below the yield's high for August.
The immediate catalyst: Katrina has exacerbated an already tight energy market, particularly in gasoline, pushing prices up and raising the specter that consumer spending will fall of a cliff. Then again, even before the hurricane, gasoline stocks in the U.S. had been falling sharply, according to the Energy Information Administration. Gasoline stocks for the week ending August 26 were the lowest since November 2003.
A lack of oil isn't really the problem at the moment; rather, the dearth of spare refinery capacity is the culprit, a problem that's been years in the making, courtesy of no new refinery development since the dark ages. Regardless, when Katrina struck, shutting operations at nine refineries, or about 10% of the nation's capacity, the supply squeeze for gasoline moved from worrisome to dire. The U.S. has long relied on the Gulf Coast for too much refinery capacity, and that bet suddenly has come back to bite the economy.
Yes, gasoline futures pulled back again today, reversing most of the two-day surge from Tuesday and Wednesday. But the refinery shutdowns aren't likely to be reversed quickly, and the question is whether the energy shock in its latest incarnation will push the economy over the edge.
On that note, some pundits are saying that the Federal Reserve will suspend the interest rate hikes that have prevailed at every Federal Open Market Committee meeting since June 2004. While such talk has kept the bond bulls happy, it's sparked renewed fears for the greenback. Indeed, one of the dollar's props of late has been the Fed's ongoing interest rate hikes. If that prop is gone, what are the buck's prospects?
Something less than bullish, or so traders think at the moment. The U.S. Dollar Index suffered its biggest declines in recent memory of late. For the week, the Dollar Index dropped 1.3%, falling to its lowest since May.
Are speculators getting ahead of themselves? After all, this morning's jobs report for August still paints a relatively rosy picture of an economy continuing to hum along. Nonfarm payrolls continued to move higher last month, with 169,000 new jobs added. That helped reduce the nation's unemployment rate to 4.9%, the lowest in four years.
But the data was compiled before Katrina's devastation has worked its way into the economic facts. As such, pre-Katrina economics reports are fated to be dead on arrival. The retail sales report for August, due for release on September 14, for instance, promises to be of little, if any consequence in weighing the future.
Instead, the post-Katrina effects are what interests the dismal scientists, and getting a handle on that will take time, perhaps months. Meanwhile, there's no shortage of predictions. "Our bet," writes TrendMacrolytics chief economist David Gitlitz today in a letter to clients, "is that these expectations [of lower interest rates of the moment] are highly unlikely to be sustained, and that the Fed's default position remains to move to restore equilibrium at a rate of 25 bps per meeting, putting the year-end target at 4.25%."
If so, that would imply the economy takes a minor hit, and a temporary one at that. But you don't have to look far to find a darker view of what awaits. "Katrina is very big and, in economic terms, very deep," warns David Kotok, chief investment officer of Cumberland Advisors, in a note to clients yesterday. "Katrina has the potential to be bigger in financial market terms than the 2004 hurricane season or any other modern American catastrophe other than war." Until there's more clarity, Kotok's counseling investors to be "very careful. It is too soon to act speculatively. The damage assessment is underway and very much incomplete. Trying to buy something new here may be like catching a falling knife. You can do it successfully but it is a high risk venture." As such, Kotok's pursuing a "defensive, shorter-duration strategy on bonds" and "maintaining the cash reserve in its ETF accounts."
The recent economic climate was complex enough. Now there's the Katrina factor to add to the analysis. For some, however, it only brings clarity. As Peter Schiff of Euro Pacific Capital observes in a note dated yesterday, "The U.S. economy, which has clearly been a bubble in search of a pin, may have finally found one in Hurricane Katrina."
Yet with so much pessimism, why is the stock market holding up so well? The S&P 500 actually rose slightly for the week. Do equity traders see a different future than the bond market? Of course. Some things never change.