September 29, 2006
A WARNING FROM JOE
Reading this morning's update on August personal income and outlays raises new questions about consumer habits for 2007. And that, in turn, raises questions about the economic outlook.
The first inquiry will center once again on Joe Sixpack's capacity for spending in the new year. Granted, it's a little early to be weighing what will come in 2007, although it's never too early to worry about what's just beyond the horizon. On that front, consider the chart below, which compares monthly changes in personal income with personal spending.
As you can see, August wasn't kind to those who think Joe's oblivious to the concept that income is finite and spending is, in theory, can be a black hole. There are many things that can change between now and the end of the year, but for the moment it's clear that it's time to rethink a world where consumer spending flies upward forever more.
To put a numerical face on the point, here's the sobering fact du jour: last month's advance in personal consumption expenditures was a thin 0.1%, the slowest since last November's 0.05%. There's no joy with personal income either, with August's 0.3% rise also posting the weakest since November 2005.
Adding insult to injury, personal saving was a negative $45 billion last month too, continuing the long-running line of monthly red ink on this measure.
Nonetheless, the optimists say that a rebound will reveal itself once September's report on income and outlays is published next month. The rationale for keeping a stiff upper lip is that the tumble in energy prices this month will give Joe and his counterparts new incentive to revive spending--an incentive that was sorely lacking during August's relatively high price of fuel.
Joe may be battered, but he's not down yet. Hope, in other words, is alive, even if it's not exactly kicking today.
September 28, 2006
THE VIEW FROM 29,000 FEET (AGAIN)
It's higher than the initial advance estimate (just barely) but considerably lower than the second guess. But no matter how you wish to interpret today's third and final measure of second-quarter GDP, there's no getting around the fact that the general trend with economic measures broad and narrow of late is down.
The real, annualized increase in GDP was 2.6% during April through June, the government reported, down from 5.6% in the first quarter. The fact that there's a slowdown in our midst is old news. The bigger question is what investors should do, if anything? In search of an answer, everyone starts with the same handicap: ignorance about what's coming. That, as they say, is the nature of risk.
The first step in mitigating that risk is diversification. The devil, of course, is in the details. With that in mind, we direct you to the dark angel's scorecard. As always, it's heavy on offering clarity about what's already passed and silent on the morrow....
September 27, 2006
The stock market has been shrugging off recent signs of weakness in the economy and the bond market has been embracing the trend. One market is wrong; one is right. We have a suspicion about which is which, but then again if we really knew what was going to happen we'd sell everything, leverage our portfolio to the sky, and put it all on the winning asset class. Alas, we're not quite sure what's lurking around the corner, and so concentrated bets in a single asset class remain the stuff of dreams in a world where limited knowledge and surprise prevails.
Diversification, in other words, is the only game in town for mere mortals with imperfect insight into the future. But as compelling as multi-asset class investing is, sometimes it's perplexing, and now is one of those times.
Both stocks and bonds have been running higher. Both markets have access to the same data, and both are drawing different conclusions.
Let's start with the bond market, where the benchmark 10-year Treasury yield has dipped below 4.6% for the first time since February. In fact, the 10-year yield has been on a slippery slope for since July, when a 5.2% current yield prevailed early in the month. The catalyst for the decline is, of course, the ongoing stream of economic reports that show the economy is slowing. (The latest is this morning's update on new orders for durable goods, which tumbled for the second straight month in August--the first back-to-back tumble in more than two years.)
The stock market swims in the same data pool as the bond market and yet equities have run higher in recent weeks. In fact, yesterday's jump in equities brought the S&P 500 to its highest level in more than five years.
The fact that bonds and stocks are moving in the same direction may be frustrating for strategic investors looking for more independence from the two major asset classes. In fact, correlations go through cycles. As the chart below illustrates, correlations between the S&P 500 and the Lehman Brothers Aggregate Bond index have been rising since bottoming out in 2003 and 2004. Even so, measuring correlation by trailing 36-month periods shows that the diversification kick born of holding stocks and bonds is battered but far from dead. For the three years through last month, equities and fixed income still had a slightly negative correlation. (For the chart, 1.0 is perfect correlation, 0.0 is no correlation, and -1.0 is perfect negative correlation for performance.)
There's a fundamental reason why owning both stocks and bonds has served as the foundation for a diversified portfolio over time: each asset class is driven by different trends. Sometimes those trends converge, in which case equities and fixed income march together. But such symmetry never lasts, and over time tends to be the exception. As such, we see the future bringing more asymmetry into the relationship between stocks and bonds. The only question is which asset class will blink first? We can afford to remain agnostic on the answer in part because we own some of each asset class. Diversification has its rewards, even if they're not always obvious in the short run.
September 26, 2006
SHELTER FROM THE STORM
Even the darkest cloud may conceal a silver lining. Or so the optimists say.
The example du jour comes by way of yesterday's report on existing home sales for August. On the surface, there's precious little to celebrate. If you were already bearish on the economy, the news that sales dropped 0.5% last month from July, and are down 12.6% from a year ago, according to National Association of Realtors (NAR), won't do much to change your vision.
Nor will the year-over-year comparisons: the median sales price dropped last month from a year ago--the first annual drop in 11 years. Another troubling trend: the rapid rise in inventory: the supply of homes for sale in August was up nearly 38% from 12 months previous.
But context is everything if you're searching for the sunny side of the street. Are you inclined to see the glass half full or half empty? Depending on your answer, you can see what you want to see by tweaking the perspective and emphasizing this and de-emphasizing that. The art of statistics offers a world of opportunity for the ambitious analyst.
Consider, for instance, that while existing home sales were down last month, placed in the context of the trend in recent years the latest numbers don't look all that bad. David Lereah, NAR’s chief economist, has an eye for seeing the positive, and said so in the press release accompanying yesterday's update. "After a stronger-than-expected drop in July, the fairly even sales numbers in August tell us the market is at a more sustainable pace,” he said. "It keeps us on track to see the third highest sales year on record, but we do expect an adjustment in home prices to last several months as we work through a build up in the inventory of homes on the market."
There's also reason to think that the future could deliver some positive surprises born of mortgage rates that are again falling. The national average rate for a 30-year, conventional, fixed-rate mortgage was 6.52 percent in August, down from 6.76 percent in July, according to NAR's press release. And last week, the 30-year fixed dropped to 6.40 percent.
"I think the worst of the drops [in existing home sales] are probably behind us, but it is way too early to say that we are at the bottom," Mark Vitner, senior economist with Wachovia bank, told Reuters via ABC News.
Some optimists also note that while the median sales price of existing homes slipped over a 12-month period for the first time in more than a decade last month, prices in the West actually rose slightly vs. August 2005. But there are limits to walking in the sun and feeling warm and fuzzy about the future. NAR's Lereah said the Western shoe could soon drop. "In California I think prices are going to have to come down harder," he advised Reuters via the L.A. Times.
You can be anything you want to be in the 21st century--bull, bear, or something in between. Being right, alas, isn't getting any easier.
September 25, 2006
THE GREAT DEBATE, FRESHLY (RE)BREWED FOR ANOTHER WEEK OF FUN
The economy may be slowing, but the accumulating evidence doesn't convince every last analyst that the future will bring a stumble.
At the leading edge of contrarian thinking on where the economy's headed is one dismal scientist who thinks the consensus is wrong and headed for a train wreck. Bonds are "riding for a fall -- the economy isn't weakening and the Fed's not going to ease," wrote David Gitlitz, chief economist at TrendMacrolytics, in a note to clients last Thursday.
The bond market paid no attention, opting instead the next day to rally and dropped the 10-year Treasury yield to under 4.6% for the first time since February. The message could hardly be more direct. The inversion of the yield curve now amounts to Fed funds at roughly 65 basis points above the 10-year. As inversions go, this one's fairly solid and so its forecast can neither be misconstrued or accidental. That doesn't make it right, but one can't claim the signal was unclear.
But if a recession is now baked into the system, Gitlitz reminds that reasonable minds can look at the same data and come to wildly different conclusions.
Speaking on the opposite side of the analytical aisle is Nouriel Roubini of Roubini Global Economics. He warned on his blog last week that a "hard landing and recession" are now a 70% probability. Among the highlights (or low points) of his forecast:
* The economy will sharply decelerate in H2 (1.5% growth in Q3 and 0% by Q4)
* The housing market will experience its biggest bust in decades and home prices will sharply fall
* The US will enter into a recession by Q1 of 2007
Gitlitz isn't entertaining anything even remotely close to Roubini's vision. On the notion of a housing bust, for instance, he counters that the recent decline in mortgage rates might "ease the housing slump upon which rests so much of the bond market's hopes for broader economic deterioration." And when it comes to the yield-curve inversion, the traditional reading may not be relevant, he continues:
It's true that significant inversions over the past two decades have correctly anticipated subsequent Fed rate cuts. But it's also true that on those occasions policy was far tighter than it is now. The 2000 inversion came when the Fed pushed the real funds rate to 4%, with a 6.5% nominal rate against core inflation running at about 2.5% year-on-year. In 1989, the real rate got as high as 5%, with the Fed's hikes topping out at 9.75%. By contrast, the current 5.25% funds rate amounts to a real rate of less than 2.5%. Rather than being tight, the Fed remains accommodative.
The bottom line for Gitlitz: "We don't believe the Fed will ease without a precipitous growth slump, and we see no indication that such a slowdown is in the works."
The Fed's FOMC meets again on October 24 and 25 to again consider the right and proper level of money's price. So far, the Gitlitz view of the world finds little support in the world of futures trading. As we write this morning, the November Fed funds contract is priced in anticipation of holding the Fed funds at the current 5.25%.
Then again, bulls and bears may both claim triumph if the pause remains intact at the next rate meeting. If the Fed truly thought a recession was coming, it would cut rates, right? On the other hand, some might reason that the Fed is worried that growth will stay stronger than expected and so prefers to keep rates unchanged for fear of cutting too early.
Perhaps, but for the moment the forces expecting economic moderation are in control, an influence that extends to the world of oil. A barrel of crude fell below $60 earlier today, a six-month low. When and if Mr. Market comes around to the Gitlitz view of the economy, oil prices are likely to be an early indicator. But today, at least, the slow-growth outlook prevails.
For the long-term strategic investor, the economic debate can be more than a little confusing. No matter, as we're still of a mind that better opportunities will emerge down the road, and so we're still overweighted in cash. At some point, valuations in one or more of the asset classes will present more compelling numbers. Meantime, we're happy to stay diversified across all the usual suspects, albeit without making aggressive bets anywhere. That will change, perhaps soon. But first, Gitlitz or Roubini must be proven wrong, a task that can only be delivered by the data.
Our suspicion is that the future will favor something closer to Roubini's outlook, if not quite so extreme. Nonetheless, the optimist in us still hopes for a scenario that tracks Gitlitz's. Call us crazy, but we prefer growth over recession. Nonetheless, we'll take what comes. More importantly, we aim to profit from it. Such is life in the cold, calculating and opportunistic trenches.
September 23, 2006
THE GREENSPAN FACTOR MAKES A TIMELY RETURN
The 10-year Treasury yield continued tumbling yesterday, falling below 4.6%, the lowest since late-February. The general catalyst: mounting worries about an economic slowdown. But yesterday's buying spree in bonds also found some unexpected support from the Greenspan effect.
Former Fed Chairman Alan Greenspan reportedly made comments Thursday evening about the prospects for a Fed rate cut, according to the Wall Street Journal. Rumors of the talk, delivered at a conference at Drake Management in New York, apparently inspired a fair amount of the buying yesterday that pushed yields lower (bond yields and prices move inversely). Nonetheless, there's some debate about what exactly Greenspan said on Thursday. The complete Journal story (available only to subscribers) notes that "two people who attended the event where Mr. Greenspan spoke said he didn't say anything about likely actions by the Fed, as some rumors suggested."
Nonetheless, rumors are a potent force these days as questions swirl about what comes next for the economy. Nature abhors a vacuum, and so do bond traders. Ours is a moment when buying Treasuries first and asking questions later is the preference du jour. The fad will continue until (and if) there's compelling evidence to rethink the trade. Meanwhile, momentum is alive and kicking (again).
September 22, 2006
ANATOMY OF A SLOWDOWN
The debate over whether the economy is slowing is dead. In fact, it's appears to have been deceased for some time. Some of us may not have realized this essential fact, but the discussion of relevance has necessarily turned to the magnitude of the decline.
The latest batch of numbers confirm what the bond market has been predicting for some time: economic momentum is slowing, and more than a little. The accumulated numbers below tell the story. Of particular interest is the Philadelphia Fed index, which tracks manufacturing activity in New Jersey, Pennsylvania and Delaware. The latest report shows that the index went negative for the first time in three years, and by a surprisingly wide margin from the previous number. Meanwhile, the Conference Board's leading index fell again by 0.2%, bringing the measure to its lowest since October 2005.
The accumulating evidence of economic downshifting inspired a fresh surge of buying yesterday in the 10-year Treasury Note. By the close of trading on Thursday, the 10-year's yield fell to 4.65%, a level last seen six months ago.
Of course, the 10-year's yield decline is nothing new, having been slipping for months. The big change yesterday is the stock market's confidence, which suddenly took a tumble. The S&P 500 slipped by around one-half of a percent yesterday. Although the upward trend in the stock market since July still appears intact, equities are vulnerable to a larger correction going forward. Much, of course, depends on the economic reports coming next week, which will inform Wall Street as to just how much the economy is slowing.
Indeed, next week is stuffed with scheduled releases of new numbers that could take a toll on equities. Among the highlights:
* Existing Home Sales (Sep 25, 10 a.m.)
* Consumer Confidence (Sep 26, 10 a.m.)
* Durable Goods Orders (Sep 27, 8:30 a.m.)
* 2Q GDP, final (Sep 28, 8:30 a.m.)
* Personal Income & Spending (Sep 29, 8:30 a.m.)
The slowing U.S. economy, in fact, seems to have company. BCA Research on Wednesday, citing a survey of analyst expectations on the global economy, reports that a continued slowdown is widely forecast.
The good news is that when cycles turn, volatility in prices in asset classes tends to rise as the markets struggle to digest the shift in trend. Traditionally, such periods produce attractive buying opportunities for strategic-minded investors.
Indeed, such opportunities have been notably lacking this year. Virtually all of the asset classes have been priced for perfection as it relates to their particular slice of the world. But something less than perfection is starting to arrive, and the repricing of risk in more than a subtle manner may have started. For those with the cash at the ready, the future may extend deals that are too good to pass up. If so, that alone would mark a considerable change from the recent past.
Of course, an enlightened investor must realize that if the economy slows, but by a degree that still manages to surprise on the upside, stocks could rally and bonds could suffer. Everything is relative when it comes to the link between prices and expectations. That's why the financial gods invented diversification. Nonetheless, redeploying capital across asset classes when expected returns rise, even on the margins, is the only game in town in the long run.
September 21, 2006
IN PERFECTION WE TRUST
There's a higher degree of respect today for the old saying: Don't fight the Fed.
In Fed Chairman Ben Bernanke's first six months on the job, such counsel was thought to be of fading relevance. But the chairman's verbal stumbles are gone while the Fed's credibility is higher, thanks to Bernanke and company's forecast that a slowing economy would complement lower inflation. So far, that prediction has proved to be accurate, and Wall Street couldn't be happier.
In fact, yesterday's decision by the central bank to hold Fed funds at 5.25% was widely expected. Fed funds futures have been predicting another pause for weeks.
But this new world order of respect for the institution that ultimately controls inflation's path is contingent, as always, on what happens next. From an investor's perspective, the future holds more than a few challenges, and perhaps some volatility in pricing because expectations in the present are fairly high and rising.
Investors seem inclined to believe that the so-called Goldilocks economy is assured--not too hot and not too cold. In this vision of future bliss, economic growth will slow enough to keep interest rates from rising, but growth will not tumble so much as to bring on a recession. Meanwhile, inflation will moderate to just the right level to stave off deflation while giving the Fed room to continue pausing and perhaps even begin cutting rates.
In a world where the yield curve is inverted, expecting perfection may be asking for more than the financial gods can deliver. A three-month T-bill currently yields 4.92%, about 20 basis points above the rate on a 10-year Treasury. Then again, perhaps this is the international signal that perfection is coming in economic and financial spheres. One has to keep an open mind in the new world order, even if we're keeping one hand on our wallets.
In any case, jubilation dominates trading in stocks and bonds. The S&P 500 yesterday on an intraday basis probed heights last witnessed in February 2001, while the 10-year yield yesterday briefly dipped to its lowest (~4.71%) since March.
Some of the buying is inspired by the correction in commodities, notably energy. With the froth coming out of prices for oil, gasoline and natural gas recently, the money is being redeployed in stocks and bonds.
But amid all the euphoria that's now sweeping Wall Street, it's worth remembering that the Fed still has work to do. The core rate of inflation still remains too high to ignore. Meanwhile, labor costs seem to be perking up, delivering what may turn out to be a headache for monetary policy in the near future.
"All the wage data show an acceleration to one degree or another yet the policy makers do not acknowledge that" in yesterday's FOMC statement, Mark Zandi, chief economist at Moody's Economy.com, told the New York Times today. "That is suggestive of a more dovish Federal Reserve. The small changes in this latest statement all suggest that the Fed will not be raising interest rates anytime soon. In fact, you can almost make the case that they are trying to drive expectations in the other direction."
To be fair, the Fed's statement did advise that "some inflation risks remain" and so "additional firming that may be needed...."
But for the moment, warnings fall on deaf ears on Wall Street.
September 20, 2006
It's too soon to declare that the Fed has once and forever stamped out the inflation embers, but it's clear that the central bank has won the current battle.
The concern that consumer and producer prices would spiral upward while the Fed kept interest rates flat has been demoted, if not yet completely quashed, as a topical worry. The FOMC meets today and will likely declare that the price of money can remain as is. In sum, the debate that the liquidity unleashed in the recent past is about to show up in official inflation numbers is dead for the moment. But the thornier issues of deciding where all the liquidity went, where it will go, and what it means for future price trends remains alive and kicking.
In an earlier era, the hefty injection of liquidity into the U.S. economy that prevailed in the years after 2001 would have delivered more of an inflationary kick, as tracked by consumer price gauges. That hasn't happened, but the reason has as much to do with deft central banking as it does with disinflationary and even deflationary winds blowing in the global economy.
The rise of emerging market economies in recent years, as The Economist points out this week, has been a major force for keeping broad measures of inflation relatively contained. As the survey asserts, emerging nations have delivered both a fresh and healthy dose of cheap labor and cheap capital to the world economy to a degree that's unprecedented. In turn, prices for a number of goods and services, along with wages, have stayed lower than they might otherwise be in the U.S. and elsewhere.
The Fed and other central banks, as a result, have found it easier to keep interest rates lower and permit liquidity to rise higher than prudence might have allowed a generation ago. But while the liquidity production hasn't come back to bite the economy, it's had an impact. Where has all that liquidity been going? It's not obvious, if one looks at the broad measures of inflation, as yesterday's producer price index and last week's consumer price report remind. But rest assured, the extra money the Fed has so generously printed has gone somewhere.
In the late-1990s, inflation arguably showed up in stock prices, which ran skyward. When the equity market collapsed in 2001 and 2002, cash found a new home in real estate. The bull market in housing in particular is said to be a boom of unprecedented proportions. Of course, that boom is now in the process of unwinding.
Liquidity has also migrated into emerging market economies, which hold 70% of the world's foreign exchange reserves, according to The Economist's latest world economy survey. That's extraordinary for a number of reasons, starting with the fact that while the lion's share of the planet's reserves are in emerging economies, those nations represent less than 20% of the world's stock market capitalization.
Imbalances are all the rage these days, and that extends to the extent that a large chunk of the liquidity held by the likes of China and India has migrated back to the United States in the form of funding of the country's current account deficit via purchases of Treasuries and other assets.
If the past is any guide, however, excess liquidity is a transient form of capital. Expecting it stay put may be expecting the impossible. If so, what does the future hold when the liquidity seeks out greener pastures? It's a timely question these days as some of the liquidity starts to come out of real estate and the global economy seems poised for a downshift in growth. Thus the question du jour: Where will liquidity go next? Perhaps it'll flow back into real estate, or gravitate back to stocks, or work its way into the economy so that the general price indices start moving up after all. Or, maybe the liquidity will surprise everyone and foment repercussions that no one can yet imagine.
Fed Chairman Ben Bernanke is on record as saying that the world has been awash with a global savings glut. That glut has been helpful to U.S. monetary policy so far. After Bernanke and company are done celebrating today, perhaps they might ponder if the global savings glut will continue to benefit the American economy, or if something might change.
September 19, 2006
ANOTHER GIFT FROM THE PRICING GODS
DUE TO A TECHNICAL GLITCH WITH OUR SERVER, WE WEREN'T ABLE TO PUBLISH UNTIL LATE THIS AFTERNOON. THE TECHNOLOGY GODS APPARENTLY ARE ANGRY WITH US. IN ANY CASE, HERE'S THE POST AS WRITTEN THIS MORNING...
Last week's report on consumer prices for August was encouraging. This morning's news on wholesale prices is even better.
Producer prices rose just 0.1% last month, the Labor Department announced. Subtracting food and energy from the mix revealed a core PPI that decline 0.4% in August. That's the second month running that core PPI fell. Falling car and light truck prices were the main factors weighing on producer prices.
Coming just a day ahead of tomorrow's FOMC meeting, today's news will likely deliver the extra muscle to insure that the Fed keeps interest rates unchanged. In fact, traders are starting to nibble at Fed funds futures this morning, providing what may be a preview of anticipating a rate cut in October.
Helping raise the prospect of a rate cut down the road is the Commerce Department's report this morning that housing starts dropped again to an annualized pace of 1.655 million--the slowest pace since April 2003. No one can doubt that real estate is now in the midst of something more than a temporary stumble.
Even so, the bond market apparently had the jitters yesterday, driving the yield on the 10-year Treasury up to nearly 4.85% at one point--the highest since late-August. But optimism has since returned, and in early trading this morning the 10-year's yield is again fallen below 4.80%. By the end of the week, even lower yields are expected.
For the moment, the optimists and doves are heroes. Meanwhile, Bernanke's star burns brighter this morning. Inflation is still a long-term enemy and the path of least resistance with a government and an economy that are hard wired to spend more than they take in. But such worries have been banished to the deepest recesses of Mr. Market's collective mind.
The trend is said to be your friend. For the moment, there's plenty of incentive to go with the flow.
September 18, 2006
THE PAST, PRESENT & FUTURE OF MONETARY POLICY
The accumulating signs of an economic slowdown in recent weeks have, in the eyes of many, confirmed the Federal Reserve's bias for pausing with interest-rate hikes. If economic growth is fated to become tepid, goes the reasoning, it will take the edge off inflation's momentum.
The conceit buried in this school of thought is that the supply of money carries marginal sway on inflation's course. That's a disturbing view for monetarists, who hold that inflation is a phenomenon driven by changes in the money stock relative to the economy.
Among the main lessons embedded in this belief is that inflation and rapid and/or dramatic price increases aren't necessarily one and the same. A shift in supply and demand moves prices. This has nothing to do with inflation, counsel the monetarists. Rather, an uninformed rise in the stock of money (i.e., a rise that's more than the general economic conditions require for maintaining an orderly functioning of the economy) is one that ultimately elevates prices, but for reasons that are detached from supply and demand trends.
A new paper that preaches the value of seeing inflation as a monetary phenomenon comes from Edward Nelson of the St. Louis Federal Reserve. The research (The Great Inflation and Early Disinflation in Japan and Germany) documents that Japan and Germany in the 1970s witnessed an inflation that peaked relatively early and generally stayed lower compared with other nations in the West, notably the United States. He concludes that the "German and Japanese experiences in the 1970s indicate that once inflation is accepted by policymakers as a monetary phenomenon, the main obstacle to price stability has been overcome."
The topic of debate before the house today is whether the "main obstacle" to price stability has been conquered in the collective mind of the Fed's leadership. The current head of America's central bank, to cite one example, has gone on record explaining that as the economy slows, so will inflation. Backing up that outlook with action, the Fed on August 8 put rate hikes on hold, an act that's widely expected to have a repeat performance on Wednesday, when the FOMC meets again to consider the proper state of money's price.
In fact, there are instances in history when an economic slowdown didn't deliver a commensurate drop in inflation, the 1970s being the egregious example. America, in particular, suffered from so-called stagflation during that decade. Nelson finds that Germany and Japan suffered less. The reason is mostly due to decisions about money supply in those countries, he counsels.
That brings us to the observation that the rate of money supply is again heading up in the United States. The M2 measure of the nation's money stock advanced by 4.9% over the past year through September 4--the highest since mid-July, according to Fed data. This is what one might expect when interest rates stop rising. Deciding if it's also the right policy at the right time, assuming it continues, is another matter.
Of course, confirmation or rejection of the Fed's current policy will come only after months and years, as opposed to the days and weeks that investors seem to think is the appropriate period for analysis. For that reason, we remain hopeful that the central bank will do the right thing in time, and that the recent trend in M2 isn't necessarily indicative of things to come in the long run. What's more, if inflation does in fact continue trending down, the risks of M2 growing lessen.
In the meantime, there is history to consider, including a variety of outcomes that central banks have dispensed over time by way of a variety of strategies. Some in the central banking system are studying that history. Only time will tell if those in the upper echelons are also availing themselves of the opportunity.
September 15, 2006
ALL CLEAR...FOR NOW
This morning's report on consumer prices for August is the gift that the markets have been looking for.
Inflationary pressures eased last month, the Bureau of Labor Statistics reported, with the CPI advancing at just 0.2% in August, down by half from July's 0.4%. The core rate of inflation, meanwhile, held steady: CPI less food and energy rose 0.2% last month, as it did in July.
The big contributors to the slowing of pricing pressures were energy and transportation. Energy prices gained by a mere 0.3% in August, a universe below July's 2.9% surge. The pace of transportation-related price hikes also took a healthy dive, registering a 0.2% rise, down sharply from the previous month's 1.6% climb.
August, in short, took a fair chunk of the momentum out of inflation's sails. The core rate of CPI is now running at an annual 2.8%. That's still a bit on the high side as far as the Fed's upper range of tolerance is concerned. Bringing core CPI down to the low 2% range is the immediate goal, and a prudent one if the central bank is still concerned (as it should be) with managing inflation as a long-term proposition. As such, the Fed will have to remain vigilant. But for the moment, there's no immediate sign that inflationary pressures are accelerating. Confirmation that the trend is more than a blip will only come in future months, but hope has suddenly taken a big step up in valuation.
Indeed, with oil prices down around 10% so far this month, a repeat performance of easing consumer prices looks on track for the September CPI report. Next Wednesday's FOMC meeting at the Fed, in short, will have fresh data to lean on for rationalizing keeping interest rates on pause.
Mr. Market has been anticipating no less. The S&P 500 has been climbing steadily if slowly since mid-July, and on Wednesday touched its highest level since May. The bulls have been in charge in the bond market too, pushing the yield on the 10-year Treasury Note down under 4.8% for much of this month--the lowest since March.
Year to date through last night's close, the total return is 6.9% for the S&P 500, and 2.2% for the widely watched Lehman Brothers Aggregate Bond Index. The upward momentum in equities is also evident elsewhere on the planet. MSCI EAFE, in dollar terms, is up more than 13% so far this year, and MSCI Emerging Markets (also in dollars) has climbed nearly 8.9% in 2006 through yesterday.
With so much having gone wrong in the recent past, the markets are inclined to celebrate now that a number of things seem to be going right. For the moment, the bulls can breathe a sigh of relief.
Having anticipated the current good news, where do the markets go from here? More of the same? The markets, after all, are about valuing the future, not the past.
But let's not spoil today's party with awkward questions. Let's save such inquiries for next week. Meanwhile, enjoy the show.
September 14, 2006
EMPHASIZE THE POSITIVE
Two data points are a drop in the economy. But the two that rolled off the wires this morning caught our attention just the same. Such is life in these data-dependent times, when every scrap of new information is inhaled in search of clues about tomorrow. In that state of mind, we found reason to do a double take at the sight of retail sales posting dramatically slower growth while import prices continue to reach upward. Was this something to worry about? Or should we simply chill and switch to decaf?
U.S. retail and food services sales for August grew by just 0.2%, the Census Bureau reported. After July's 1.4% surge over June, 0.2% looks a tad thin. Meanwhile, the Labor Department advised that import prices jumped 0.8% last month and the original estimate for July was revised up to 1.0% from a mere 0.1%. The combination of slowing consumer spending and rising prices by way of the nation's voracious appetite for imported goods is something less than ideal at this moment in the economic cycle. Gee, what will Bernanke think?
Of course, one could opt to emphasize the positive, such as it is. Let's give it a whirl, shall we? Let's start by noting that the 0.2% rise in retail sales is an improvement over the consensus outlook that called for a slight decline of -0.2%. In addition, retail sales look more robust by comparing August's tally to its year-earlier total. By that measure, retail sales jumped 6.7% on the year, or more than twice as high as the economy's pace of growth in the second quarter. Not too shabby for a consumer population that's thought to be laden with debt.
David Resler, chief economist at Nomura Securities in New York, finds reason to see the glass half full rather half empty on the retail front. The "underlying retail trend has picked up a bit after a sluggish second quarter and seems to be growing at a pace that is consistent with trend-like growth in overall consumer spending," he wrote in a note to clients this morning.
Over on the imports ledger, prices are advancing at a far slower pace once you remove energy from the calculation. While import prices overall rose 0.8% last month, the climb was a lesser 0.5% for non-petroleum imports. The year-over-year record is also slower once you take out energy: 2.7% vs. 6.6%. In addition, the 12-month rate of change for top-line import prices slowed again last month, as it has in the two previous months. The trend, at least, is encouraging. Meanwhile, the fact that oil prices have been dropping of late adds to the hope that the import prices will be revised down.
Mr. Market, in fact, continues to emphasize the positive. The initial reaction among traders in Fed funds futures to the news this morning on retail sales and import prices tells the story: the October contract is virtually unchanged, priced in anticipation for more inertia at next week's FOMC meeting, i.e., keeping Fed funds at 5.25%.
Steady as she goes, an optimist might say. One more hurdle before the weekend. Let's see how cheerful we are after reading tomorrow's report on August consumer prices. Meanwhile, optimism springs eternal...at least through the end of trading today.
September 13, 2006
DISSECTING BULL MARKETS (AGAIN)
A new research paper that analyzes the timing of stock market booms around the world in the 20th century in relation to macroeconomic conditions probably won't surprise enlightened observers of the money game. But what the paper lacks in shocking disclosures it makes up with a timely reminder that equity bull markets tend to thrive under a particular set of conditions. Conditions, some argue, that appear to be on the wane these days.
Indeed, a new working paper published on the St. Louis Fed's web site, When Do Stock Market Booms Occur? The Macroeconomic and Policy Environments of 20th Century Booms delivers fresh reason to wonder if the current run in stocks still has legs. "We find that booms generally occurred during periods of above-average economic growth and below-average inflation, and that booms typically ended when monetary policy tightened in response to rising inflation," write authors Michael Bordo (an economics professor at Rutgers) and David Wheelock (an economist at the St. Louis Fed). "Most booms were procyclical, arising during business cycle recoveries and expansions, and ending when rising inflation and tighter monetary policy were followed by declining economic activity."
How does that trend relate to the outlook for stocks in 2006? Or, perhaps we should ask, does it relate at all? Before we can even take a shot at an answer, there's the awkward problem of deciding if the economy is currently winding down, heading up or set for an extended period of treading water. Alas, the jury is out on this one--way, way out, to judge by the degree of uncertainty that permeates the economic news of late.
To be sure, a considerable downshift in economic growth has been recorded in the second quarter relative to the first. Meanwhile, there's any number of reasons to think that the slowdown is more than temporary, including the widely publicized slippage in the housing market. But the optimists aren't giving up just yet.
The latest catalyst for thinking that the old bull isn't dead yet comes by watching the decline in oil prices. A barrel of crude is priced under $64 in New York trading, the lowest since March, and down by more than $10 since early August. Hardly a bargain by the standards of the past decade, but the direction at least is expected to cheer the consuming masses.
Today's Wall Street Journal ran a story that explores the potential for a fresh burst of consumer spending fueled by the recent drop in energy prices. Although some dismiss the idea outright, others still find reason to think that a second wind is possible in the current cycle. Robert Mellman, senior economist at J.P. Morgan Chase, is one dismal scientist who thinks that Joe Sixpack may find inspiration anew for pulling out his credit card down at the local mall. Lower gasoline prices could raise the annual pace of consumer spending a full percentage point, he told the Journal. In turn, the annualized fourth-quarter economic growth would jump to 3.7% from an expected 3.0%.
Of course, oil and gasoline prices need to stay down for more than a few weeks to deliver tangible results. We'll see.
Meanwhile, Bordo and Wheelock's research raises some provocative questions at a time when inflation, while still relatively low, has ticked up. Stock market booms, the authors write, "typically arose when inflation was low and declining, and ended within a few months of an increase in the rate of inflation. Rising inflation tended to bring tighter monetary conditions, reflected in higher real interest rates, declining term spreads, and reduced money stock growth."
Among the many questions weighing on Mr. Market comes one more that's inspired from Bordo and Wheelock's research, namely: Does the paper's observation of the past inform investors about what comes next?
September 12, 2006
WAGERING ON WAGES
There are many things to fear when looking at the economy and its capacity for surprising, and wages taking wing may be one of them. Of course, if you're a long-suffering worker, the trend is worthy of celebration. But expecting the pace of labor income to keep running higher is something to lose sleep over if you're a central banker (or an investor betting that rates will stay flat or fall).
Indeed, the subject or wages promises to be the new new thing as 2006 goes into its final stretch. To be precise, how much of the bubbly wage growth of late will be inflationary? Or, to summarize the optimists, will the upward trend in wage growth be offset by productivity gains and weakness elsewhere in the economy, notably in real estate? Such are the questions that keep investors wondering and economists working.
Analysts Charles Dumas and Gabriel Stein of Lombard Street Research in London believe that the folks at the Fed may lose a little shut-eye in the foreseeable future. Stein wrote yesterday in a note to clients that "labor income growth is accelerating" in the U.S. His colleague, meanwhile, observed last week that "huge" revisions on wage growth estimates point to more Fed tightening.
Not everyone agrees, of course, and we'll get to that shortly. But first, a closer look at Lombard's analysis, starting with Stein. The U.S. economy is entering what he calls an anti-Goldilocks phase, which he defined as "both too hot and too cold at the same time…." Too hot, he continued, "in the sense that household incomes clearly remain strong and are likely to keep powering the economy for some quarters further. In fact,
with non-farm labor income rising by 6%, household spending by itself should be enough to propel the economy to close to trend rate growth--always assuming, of course, that the savings rate does not suddenly begin to rise."
If history is a guide, the latter seems unlikely, at least any time soon. Joe Sixpack has been conspicuously profligate for years when it comes to spending, which suggests that the prospect of rising incomes will further fuel his fondness for running down to the mall and pick up another TV or two.
In any case, Stein added that while household incomes have been bubbling, the housing market has been cooling. The combination of hot and cold will "bedevil the Fed" on through 2007, he predicted. Ultimately, however, another increase in the Fed funds rate will come, he predicted.
Meanwhile, Dumas has been watching the revisions to hourly pay estimates and found that the bias has been upward in more than a trivial way. The trend, he concluded, has diminished the chances for a "serious" economic slowdown for the foreseeable future. As such, he too predicted that the Fed will be "forced into tightening."
But Ed Yardeni begs to differ. The chief investment strategist for Oak Associates is a bull, and makes no apologies. He wrote in an email to clients this morning that rising productivity will help save the day by keeping a lid on any inflationary pressure born of increased spending by way of rising incomes. Meanwhile, the second-quarter's 7.7% annual jump in nonfarm business hourly compensation (the biggest since 2000) "is mostly attributable to profit-sharing," he counseled, effectively dismissing its powers to elevate inflation by any magnitude.
Nonetheless, observers should take note that even Yardeni agrees that incomes aren't flat, as some pundits assert. "Despite all the nonsense that American workers' incomes have stagnated for the past five years," he wrote, "inflation-adjusted hourly compensation for both the [non-farm business] and [nonfinancial corporate] sectors were at record highs during Q2, up 10.6% since the start of the decade and up 24.0% since Q3 1995!"
The debate, then, is not over whether incomes are rising at a healthy clip these days. Rather, the question is what will the trend do, if anything, to offset the slump in real estate, which is said by some to be the catalyst for a slowdown or even recession in coming quarters? Also, while we're asking questions, what effect will rising incomes have on inflation going forward? Yardeni, Stein and Dumas have a view. The great unknown how the Fed will react.
As for Mr. Market, he's staying calm for the moment when it comes to looking ahead for monetary policy. October Fed funds futures could hardly be less volatile these days. The contract continues to be priced in anticipation that next week's FOMC meeting will keep Fed funds at 5.25%. The pause, in short, is still thought to have legs.
September 11, 2006
The early reports out of Vienna today are that OPEC will maintain its production output. That's cheered the bears, who've continued to sell crude oil contracts in New York today. As we write this morning, the October contract was trading around $65.50, down about $11 from mid-August.
The prospect of maintaining oil production at current levels with a forecast of slowing global demand inspires selling, of course. Adding to the bearish outlook is the recent news of a major oil and gas find in the Gulf of Mexico. Cambridge Energy Research Associates reports that as much as 800,000 barrels of oil a day could begin flowing from the Gulf's latest discovery starting as early as 2012.
Surveying the current scene in crude, The Wall Street Journal opines, "For the first time in a long while, it doesn't seem like the world is conspiring to push energy prices higher."
We're not about to argue with Mr. Market's latest pricing, but we're the first to recognize that oil is a commodity and therefore subject to the bias of the moment. As a short-term proposition, that means volatility, providing opportunity to those inclined to wade into the speculative waters. The long-term, however, is something else.
We've heard a lot lately about the promise of new technologies to supply the world with oil that would otherwise remain lost. The latest discovery in the Gulf of Mexico is testament to the power of that technology. Indeed, the oil found in the Gulf is more than five miles below the water's surface. That kind of discovery, experts say, would have been technically impossible even a decade ago.
Time marches on and oil discovery and production technology improves. But while the outlook for production on a relative basis looks better, demand isn't standing still either. In fact, when one puts the latest Gulf discovery in perspective, it's something less than extraordinary for Americans. Once again, the numbers tell the story.
The United States consumed, as of September 1, 2006, oil at the rate of more than 21 million barrels a day, according to the Energy Information Administration. The new discovery in the Gulf, in other words, represents less than 4% of daily consumption--and the new supply is still at least five years away.
A lot can happen in five years, and we're confident that the next five years in oil will look like the previous five when it comes to supply and demand trends in the United States. Using EIA data, here's a quick recap of how September 1, 2006 compares with 2001 data:
* U.S. average daily oil production (including Alaska): down 12%
* U.S. average daily oil consumption: up 5.1%
The combination of falling production and rising demand in the U.S. means that the country's oil deficit has jumped by an average of nearly 2 million barrels a day since 2001--more than twice as large as the latest Gulf discovery's potential output. What's more, that deficit born of falling domestic production and rising domestic demand threatens to continue indefinitely. All the technological advances of the last 30 years have not been able to stop the slow but stead fall in American oil production. Meanwhile, all the warnings in the world haven't been able to stop America's consumption. That's the nature of growth.
The bottom line: the U.S. must run faster just to stay in place when it comes to oil production. The latest discovery in the Gulf is indeed a "significant find," as they say, but by the time it comes on line in five years it'll be somewhat less significant. Discoveries and new production must be offset by declines elsewhere in the system for proper oil accounting.
No wonder, then, that the last five years have witnessed U.S. oil imports rise by 11%. If that pace or something comparable continues, which many analysts say is probable, we're going to need a lot more Gulf discoveries of the magnitude announced earlier this month. Unfortunately, the number of analysts predicting that pace of discovery is exactly zero.
FIVE YEARS LATER...
Five years ago this morning, two planes slammed into the World Trade Center, killing nearly 3,000 innocent people and forever changing the course of history. Your editor had been at WTC the day before, attending the first of a two-day economics conference. On September 11, 2001, thanks to an early morning dentist appointment, I was running late. Standing on a railroad platform, awaiting the next train into the city, I heard the news of the first plane. The train never came, I never made it to New York and I'll never forget what happened next.
Today, as we look back and mourn, we can only wonder what the next five years will bring. Much has changed over the past 60 months, and no doubt much will change in the next 60. But this much, at least, is clear: the United States survived, even thrived.
To be sure, America faces more than a few economic challenges. So what else is new? And while we're cautious and increasingly prudent in deploying capital, we're still optimistic that enlightened investors can turn a tidy profit in the long run.
That optimism springs largely from the belief that the United States will prevail. For all the debate about the wisdom of the country's current policies, CS harbors an unshakable belief that a triumphant America will ultimately benefit all rational-thinking people who cherish liberty. Alas, getting from here to there will be neither easy nor swift. Nothing worth achieving ever is.
September 10, 2006
The New York Times today debuted a new quarterly magazine dedicated to the asset class that has provided so many with so much for so long.
Identified as The New York Times Real Estate Magazine, The Key is replete with ads that are occasionally interrupted with editorial dispensing topical advisories for the masses such as "Which Renovations Will Add the Most Value to My Home?" and "What You Get For $750,000 In...." As every attentive student of the housing market knows, the answer to the latter is, more than last week (and a lot more than last year). The burning question: Will $750,000 bring even more next year (or next week)?
Meanwhile, we can bide our time by debating if The Key represents a timely unveiling or a sign of a top. The answer may arrive sometime in the fourth quarter when we discover if The Key unlocks its future with a second issue.
September 8, 2006
REAL ESTATE RISK: IT'S THERE, BUT WILL IT EXPLODE?
The next big thing for economy is thought to rely heavily on real estate. Exactly what that will bring is yet to be determined, but that doesn't stop speculation, including the question on everyone's mind: How will the correction now underway in housing affect consumer purchasing? A little, a lot, or something in between?
Everyone has a theory, but as of yet no one has a definitive answer. That's the nature of the future: it's unknown until it arrives. Nonetheless, the question about real estate is a loaded query, based on the fact that the collective spending habits of Joe Sixpack and company represent 70% of GDP. Add to that the recognition that housing tends to represent the biggest item on the balance sheet for any given consumer. As a result, boom and bust, bull and bear are largely determined by Joe and friends, which can be influenced by real estate.
Because the recent past has been marked by spending--inordinately so in the eyes of some--it's been easy to assume that more of the same is coming. Exactly how much real estate corrects, and exactly how much that influences consumer spending remains the great unknown. But it's clear that a connection exists between the two, and perhaps more than a casual observer realizes, suggests a new report from the IMF, which will be included in the next installment of the group's World Economic Outlook, scheduled for release next week.
Thanks to new technologies and deregulation, it's become easier to borrow against the value of homes in the U.S. to finance consumption, the IMF advises. Consumers have availed themselves of the opportunity, but it's come at a price: higher debt. The trend isn't limited to America. Households in nations with relatively flexible and open economies on par with the U.S.--so-called arm length economies--have witnessed a similar trend in borrowing and debt.
"Well developed arm’s length financial systems, such as those in the United Kingdom and the United States, enable households to borrow against the rising value of their homes, thereby boosting consumption and supporting strong economic growth," the IMF counsels. This,
however, results in households having higher debt—an average of 160 percent of disposable income in 2005 in arm’s length systems compared to less than a 100 percent in more relationship-based systems. Households in arm’s length financial systems are therefore more vulnerable to rising interest rates and a downturn in asset prices. So, for example, during previous housing busts in countries with more arm’s length financial systems, consumption growth typically slowed from an average of 3 percent (year-on-year) at the start of the bust to zero two years later. The slowing of the U.S. housing market is a key risk for the U.S. and global economic outlook.
The fear that U.S. households have taken on a relatively large amount of debt, courtesy of the housing boom of past years, is supported by the trend in the Federal Reserve's financial obligations ratio (FOR) for homeowners, a gauge looks only at payments on mortgage debt, homeowners' insurance and property taxes relative to disposable personal income. By this measure, homeowners' debt level in the first quarter of 2006 reached its highest in more than a quarter century, as the chart below illustrates.
The bull market in household mortgage debt doesn't insure that consumer spending is set to slow, but neither does it inspire confidence that Joe can maintain the torrid pace of purchasing he's set in the past. In fact, judging by Wednesday's release of the Fed's Beige Book report,a survey of economic conditions across the nation, both optimists and pessimists can find support for their outlook.
"Consumer spending increased slowly in most [Federal Reserve] Districts, weighed down by sluggish sales of vehicles and housing-related goods," the Beige Book reported. "Consumer spending increased modestly in most Districts since the last report, though a few Districts reported flat to declining sales. In general, sales of autos and home-improvement and other home-related goods tended to be weaker than for other categories."
Overall, a variety of strength and weakness was observed in the Beige Book, leaving investors room to rationalize any forecast they want about where the economy's headed. But today's guesses will give way to fresh data. As the search for clarity intensifies, so too will the focus on each new data point. Next Thursday's update on August retail sales and business inventories, as a result, promises to draw more than average attention. It's but one more data point, but any number's as good as the next as an excuse to review, reassess and re-examine.
September 7, 2006
REIGNITING THE INFLATION DEBATE
Fed Chairman Ben Bernanke has recently enjoyed some days when the data release du jour supported his view that a slowing economy would lessen inflationary pressures. Yesterday wasn't one of those days.
The Labor Department on Wednesday revised the pace of labor costs in the second quarter to 4.9% from the earlier 4.2% estimate. What makes the increase notable is that the same report also revised upward the output per hour for the nonfarm sector (also known as a measure of productivity) to 1.6% from 1.1%. "Usually, this would get translated directly into an equal sized downward revision to unit labor costs, but the GDP report also included unusually larger upward revisions to labor
compensation during the first six months of this year," wrote David Resler, chief economist at Nomura Securities in New York, in a note sent to clients yesterday.
For some dismal scientists, the trend in labor costs is worrisome as it relates to inflation's outlook. "You have a very pronounced acceleration in [unit labor costs] and the people at the Fed who are concerned about entrenched inflation will regard this as a very grave development," Pierre Ellis, senior economist at Decision Economics in New York,told Reuters.
Another economist echoed that view in an interview with Bloomberg News: "Of all the economic data out there right now, labor costs are sending the strongest warning signal on inflation,'' said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings. "I don't think the Fed can dismiss this.''
The bond market took the hint and sold off again yesterday, elevating the yield on the 10-year Treasury to back above 4.8% for the first time since August 29. Stocks followed, with the S&P 500 falling 1% on the day yesterday.
Adding to the notion that the economy may not go quietly into retreat, and thereby give the Fed the freedom to cease and desist with future interest rate hikes, was yesterday's news that the service portion of the economy remains strong. The ISM Non-Manufacturing survey for August showed that the services sector, which accounts for about two-thirds of the economy, picked up its pace of growth last month vs. July.
Meanwhile, this morning's latest on weekly jobless claims reveals a drop in the number of people filing for unemployment benefits for the week through September 2 to the lowest level since late July.
If this looks like compelling evidence to some that the economic soil is still fertile for elevating pricing power, not everyone agrees. If inflation is again the new new worry, why did gold, the historic inflation hedge, tumble yesterday? Meanwhile, traders in Fed funds futures still expect Bernanke and company to hold steady on interest rates next week when the FOMC meets. The October Fed funds futures contract remains serenely unchanged in the wake of yesterday's news.
We're all still data dependent, as Mr. Bernanke likes to say, but the data's still singing more than one tune. David Kotok of Cumberland Advisors identified the central challenge this morning in an email to clients:
My good friend and fishing partner, Wachovia’s Chief Economist John Silvia, summed it up succinctly this morning. He said: "The challenge with Unit Labor Costs is that we don’t know how much is going to come out of profits and how much will go into inflation."
September 6, 2006
LOOKING FOR UPSIDE SURPRISES
Is the U.S. economy poised for a third-quarter rebound?
That's a forecast that some analysts are making, which would spell trouble for the bond market, which has been predicting the opposite. But the fixed-income set suffered a mild loss of confidence in Tuesday's session, and in the process lent credence to the idea that the rate of growth in GDP for the third quarter will top the second-quarter's pace.
The yield on the 10-year Treasury Note reversed course yesterday in no uncertain terms, rising to 4.78%, up from 4.73% on the previous close. It was the biggest one-day selloff in the 10-year in nearly two months (bond yields and prices move inversely).
Among those leading the charge for reassessing the prospects for economic growth is David Gitlitz, chief economist at TrendMacrolytics. In a note sent to clients yesterday, Gitlitz warned that the recent rally in the bond market was destined for a rude awakening as evidence of a third-quarter revival mounts in the coming weeks. The real opportunity in bonds, he wrote, "is on the short side -- an opportunity that will crystallize when the evidence of reaccelerating growth and continuing inflation pressures become utterly unmistakable, and when there can be no further denial that the Fed's next rate move will be higher, not lower."
For the moment, however, the reported numbers show only an economy that's slowed considerably. The quarter-on-quarter rise in U.S. GDP was 0.7%, or half as fast as the first-quarter's pace. But the slowdown is set to reverse course in the third quarter, or so the OECD projects, with GDP advancing by 0.9% once the final tally for the July-through-September is published.
The notion that the economy is set to bubble a bit more than expected has also been getting a boost lately as oil prices have tumbled. In mid-July, crude briefly broke above the $80 a barrel mark--an all-time high. Yesterday, the October contract for oil closed in New York at just over $68.
The latest catalyst for thinking that oil may fall even further is the news of a major oil find in the Gulf of Mexico--a discovery that some say may boost U.S. reserves by 50%. Even if that optimistic projection turns out to be true, it won't have much impact on reducing America's dependence on foreign oil. But for the moment, the prospect of lower energy prices supports the belief that third-quarter economic growth could surprise on the upside.
Perhaps, although the slowdown in housing remains the big unknown. Even most optimists on the economy concede that the reversal of fortunes in housing is keeping expectations in check. And for good reason. The latest warning sign for real estate came by way of yesterday's update from the Office of Federal Housing Enterprise Oversight (OFHEO), which reported that home prices "fell sharply" in the second quarter. "Appreciation for the most recent quarter was 1.17 percent, or an annualized rate of 4.68 percent. The quarterly rate reflects a sharp decline of more than one percentage point from the previous quarter and is the lowest rate of appreciation since the fourth quarter of 1999," an OFHEO press release advised.
Ed Yardeni, chief investment strategist for Oak Associates, has been bullish on the stock market for some time but admits in an email to clients yesterday that the housing bubble is "certainly losing air." In fact, he sees more real estate stumbles coming, including another downshift in home sales. "Rising mortgage rates and high home prices have depressed demand," he explained. "Both new and existing median home appreciation rates have peaked, so would-be buyers aren't racing to purchase homes because they are more concerned that prices might move lower than higher." Meanwhile, Yardeni observed that large- and mid-cap equity forward earnings projections are "edging down slowly" while the outlook for small-cap stocks is "weakening fast."
Nonetheless, Yardeni doesn't think a housing recession would trigger the same in the economy overall. "Construction spending remains in record territory as a sharp drop in residential investment has been offset by big gains in nonresidential and public construction spending over the past year," he reasoned.
Gitlitz made a similar argument in defense of his prediction of ongoing economic strength:
The cooling housing market has been a linchpin for hopes of a broad economic deceleration. But the latest GDP data offers no support for that notion. On the contrary, while residential investment accounted for a -0.63% drag on the growth rate, this was nearly entirely offset by a 0.6% boost to growth from nonresidential structural investment.
Nonetheless, even Gitlitz doesn't expect the Fed to start hiking rates again when the FOMC meets next week on September 20. That, he predicts, will have to wait until the October 24/25 meeting.
Indeed, the Fed funds futures for October are anticipating that next week's Fed meeting will hold rates steady at 5.25%. Mr. Market, in short, needs more convincing that stronger growth awaits.
September 5, 2006
GLOBAL NUMBER CRUNCHING
Europe is hot, according to S&P/Citigroup Global Equity Indices.
For 2006, European Emerging equities lead the horse race through yesterday, delivering a 34.5% total return, S&P/Citigroup reports. Europe overall hasn't done all that bad either, posting a 22.2% return this year. But as the chart below reveals, stellar returns haven't been standard around the globe. Even so, the bottom performer (Mid-east and Africa) managed to eke out a 1.6% rise.
Past performance is no guarantee of future returns, as they say, although it does provide some perspective on what may come next. Perspective, such as it is, seems like a timely subject now that the summer is unofficially over and thoughts turn again to work. And just in time to greet the returning hordes to their desks comes a fresh forecast from the OECD, which has published a new outlook on the G7 economies. The outfit opines that GDP growth for the biggest economies will remain steady in the third quarter compared to the second, although signs of slowing will become more evident, if only slightly, once the fourth quarter arrives.
With that in mind, where does value reside in the world equity markets? As always, coming up with an answer is complicated and therefore risky endeavor. But a 1,000-mile journey starts with the first step. With that in mind, we begin by looking at the globe's equities by dividend yield. On that score, Asia Pacific ex-Japan offers the best relative payout at around 3.3%, or nearly twice as high as U.S. equities.
There is, of course, more than one way to define value. As such, here's a look at three more fundamental rankings of world equity markets (return on equity, price-to-cash flow and trailing 12-month price-to-equity ratios), all courtesy of data from S&P/Citigroup Global Indices.
September 1, 2006
The new new bull market in bonds that began in early July picked up steam yesterday, pushing the yield on the benchmark 10-year Treasury down to 4.73%--the lowest since March. As recently as late June, the yield was nearly 5.25%.
A casual observer might wonder if something dramatic had changed in the last two months to convince bond traders to buy, buy, buy. Yes, there's been more than a little evidence that the real estate boom is becoming something less, although the jury's still out on whether that will deliver a fatal blow to the economy or just a mild slap on the wrist.
Adding to the complication of figuring out what lurks (or doesn't) around the corner is this morning's update on August employment. For those looking for decisive evidence that an economic slowdown of some magnitude is upon us, the latest batch of numbers is sure to disappoint. The jobless rate, for instance, slipped a bit last month to 4.7%, or near the lowest levels in the past five years.
Meanwhile, the consensus outlook predicted a rise of 125,000 in nonfarm employment for last month, according to TheStreet.com; the actual number came in slightly higher, at 128,000, which is also higher than July's 121,000 increase.
The fact that the labor market continues to hold up may be frustrating for some who are expecting the apocalypse, but numbers are numbers. And that includes the fact that the nonfarm payroll reached yet another record high last month: 135.5 million. True, the August advance is up only 1.3% from a year ago--the slowest annual pace of increase in the monthly numbers since last October, as illustrated in the chart below. Nonetheless, the economy is still growing and creating new jobs, and at a rate that, while hardly extraordinary, is still within the range of recent history.
Adding yet another layer of optimism to today's employment report is the implication that inflation isn't accelerating. That, at least, should hearten the bond bulls and extend fresh credibility to the Fed's recent decision to pause on hiking interest rates. The tepid rise in hourly earnings last month suggests that wage pressure on prices has moderated, at least compared with the much-higher pace posted in July.
For the moment, signs of a slowdown or worse have been put on hold. Tougher times may in fact still be headed this way for the economy, but bond traders will have to decide if they've overplayed their hand in betting that the American jobs machine is set to take a tumble. The data gods are sitting on the fence, and bulls and bears alike must sweat it out until clear signals emerge. Suffice to say, clarity is arriving at its own sluggish pace.