April 27, 2007
Q1 GDP STUMBLES
The economy's slowing. That's old news. What's fresh is the revelation that the pace of downshifting is quite a bit steeper than some have been expecting.
The government this morning advised that first quarter GDP grew by a meager 1.3%, based on an annualized real pace. That's sobering for a number of reasons, starting with the fact that it's materially below the fourth quarter's 2.5% rate. In fact, 1.3% is below every quarterly GDP change since the first quarter of 2003. Meanwhile, the consensus forecast called for something much higher today, at roughly 2.0%, according to TheStreet.com.
Judging by recent history, when GDP's pace falls this low, it's not a good sign about the future. Akin to a plane with a stalled engine, there's a risk that the momentum may stall. It's not fate, but only a fool would ignore the danger.
Yes, today's GDP report is the first of three estimates on the nation's economy, offering the possibility that subsequent updates may revise the growth rate upward. But let's not gloss over the fact that consumer spending--the single-large factor in the economy--is showing signs of age in the latest quarterly profile. Although personal consumption expenditures (PCE) rose by 3.8% in the first quarter, that's down from 4.2% previously. That's hardly a problem, but the question is whether Joe Sixpack is now inclined to slow his pace of spending? For the moment, erring on the side of caution seems reasonable, at least from an investing perspective.
To be sure, a fall in exports and a rise in imports, combined with a drop in federal government spending all conspired with a slower rate of PCE to put the brakes on GDP in this year's first three months. But there are other warning signs, including the upward drift in initial jobless claims, as we discussed yesterday. Meanwhile, Thomson Financial is expecting earnings growth for the S&P 500 to come in at slightly above 7% for the first quarter, according to USA Today. If so, that would end the run of double-digit earnings growth that's prevailed for more than three years in quarterly updates.
Economists will no doubt argue endlessly over where the economy goes from here. No doubt there are more surprises on the way, both pro and con. But it's clear that strategic-minded investors should watch closely for rebalancing opportunities coming their way in the weeks ahead if perceptions give way further to fresh data. As we've observed for some time now, all the asset classes have been rallying. That's a wonderful trend, but it's unusual and it can't last.
Rest assured, more turbulence is coming on the macro level. Or so San Francisco Fed President Janet Yellen suggested yesterday when she the central bank may be facing the twin challenges of slowing growth and inflation. "The inflation risks are skewed to the upside," she observed, via Bloomberg News. At the same time, she's expects growth to slow. In fact, she said growth had slowed to a "crawl." The ongoing fallout from housing is a factor. It may turnaround later in the year, she offered, "I...wouldn't want to bet on it," she added.
What to do? She recommended "watchful waiting," for policy makers. That may or may not be prudent for an institution charged with fighting inflation. But for investors, it's just what the doctor ordered, at least for those of us with an overweighting in money markets burning a hole in our portfolio pocket.
April 26, 2007
Every data point is studied with increasing scrutiny. We're all looking for a sign, a clue, a crumb, anything that could impart insight about the future. At the same time, we all know that the economic cycle is no spring chicken, having been running for several years now. Yet to judge by the stock market lately, the bulls have it all figured out: more of the same will prevail.
Amid that backdrop comes the latest weekly number for initial jobless claims. On first glance, the trend looks good. The Labor Department reported this morning that the number of workers filing for jobless benefits fell by 20,000 for the seven days through April 14 from the previous week. That's the largest decline in more than two months. In fact, the size of the fall surprised economists, who had generally been expecting something on the order of a 10,000 decrease.
All told, a total of 321,000 people asked to be put on the unemployment rolls for the week through April 14. The total's fairly middling, as the range of initial claims has generally bumped around within the 300,000-350,000 range for more than a year. But if you're inclined to worry, you'll take note of the larger trend, namely: the year-over-year percentage change in jobless claims has been trending higher for some time now.
As our chart below illustrates, the rolling 52-week change in new filings of jobless is pushing higher. By itself, the figure is just one of countless economic measures that go into the mix of deciphering the big picture. But for those who ask if the economy looks any better than a year ago, here's one metric that fosters doubt about what's coming.
Of course, such gloom contrasts with the capital markets, where the Dow Jones Industrials closed above 13,000 for the first time ever yesterday. The rise in equities is the all more impressive given that there's nary a sign that the Federal Reserve will cut interest rates any time soon, or so Fed futures suggest.
What could derail the trend? For the moment, nothing. "The momentum is so strong," Sal Morreale, a trader at Cantor Fitzgerald, told The Washington Post. "I'm amazed." So are we.
The questions of whether the economy is slowing (it is), and by how much (yet to be determined), and what the fallout will be (who knows?) are only dormant, not dead. But such questions can't be posed in mixed company, at least not this week.
April 25, 2007
KEEPING HOPE ALIVE
This morning's update on durable goods orders is just what the optimists need. As a leading indicator of future economic activity, a positive reading in this space provides one more reason to think that a recession is that much further off.
Or so one could reason after digesting the numbers. New orders for manufactured durable goods rose 3.4% last month, the U.S. Census Bureau announced. That's up from a 2.4% jump in February. In fact, advance durable goods orders rose in four of the past five months, as the chart below shows.
Encouraging as the recent record is, there's still reason to reserve judgment about what it all means for the economy down the road. Although durable goods orders have been pushing higher lately, the gains tend to pale compared to the losses, which have been less frequent but much bigger in relative terms.
The 8%-plus decline of last October and again in January have helped offset the relatively modest gains of late. As a result, the dollar value of the new durables goods orders fell 2.1% last month compared to a year earlier. In fact, as our second chart below reminds, looking at durable goods orders on an annual basis provides little, if any, comfort that a turnaround is underway. The durable goods ship, in sum, continues to take on water from a longer-term perspective.
Optimists aren't quite out of arguments yet, however. Turnarounds--if that's what we now have--emerge from an otherwise pessimistic context. Bear markets continue to be bear markets until they don't; sales fall until they don't.
Perhaps the recent, albeit modest strength in new durable goods orders will continue, and perhaps accelerate. Then again, perhaps not. We don't know, and neither does any one else. The future's uncertain as always.
That said, the forces of growth and contraction continue to battle, and for the moment there's no clear winner. If we had to give one side or the other an edge, we'd pick growth. But that could change quickly in the current climate. Indeed, the edge we perceive comes with precious little margin for error. The potential for downside drama in economics reports remains alive and well, as yesterday's sharp drop in existing home sales reminds.
April 24, 2007
BLAME IT ON THE WEATHER
The initial estimate of GDP for the first quarter is schedule to arrive on Friday. The consensus forecast calls for a 2.0% annualized rise, according to TheStreet.com. That would mark a slowdown from 2.5% in last year's fourth quarter.
Still, 2.0% wouldn't be the end of the world. But after reading this morning's 8.4% slump in existing home sales for March, might there be a rationale for thinking that the economy's growth will be slower than the crowd thinks?
Indeed, the fall in real estate transactions last month brings the total home sales to its lowest since June 2003. The National Association of Realtors, which crunches the statistic, tried to put the best face on the news by blaming the weather on the slump. In addition, comparing this year's 1st quarter home sales to the year-earlier period paints a brighter picture.
“For the last couple months we’ve been expecting a weather ‘hit’ on home sales finalized in March," said David Lereah, NAR’s chief economist, in a press release that accompanied the numbers. "But looking at overall activity in the first quarter we see that existing home sales averaged 6.41 million – a figure that is moderately higher than the sales pace during the second half of 2006." He went on the note, “We also may be seeing some losses as a result of the subprime fallout. However, this is masking improved fundamentals in the housing market, with lower mortgage interest rates and motivated sellers."
But none of this sways another dismal scientist from embracing a gloomier view. "Though lower sales were widely expected to offset the unexpected strength of earlier months, the breadth and depth of this decline leaves little doubt that the housing sector remains in the doldrums with a turnaround not yet on the horizon," wrote David Resler, chief economist at Nomura Securities in New York, in a note to clients today.
Tomorrow brings updates on new home sales and durable goods, along with the Fed's perspective on the regional economies via its Beige Book report. Then on Thursday, there's another take on the latest weekly jobless claims. But the big news promises to come on Friday with the GDP number.
While we're waiting, here's how some of the relevant numbers stack up as we write. As the table below suggests, there's reason to think that adjusting expectations down carries some weight at the moment.
April 23, 2007
TOO EARLY TO TELL
The current economic expansion is now well over five years of age. To judge by the comments of Fed Governor Frederic Mishkin on Friday, one could reasonably assume that celebrating a sixth anniversary is a distinct possibility.
Yes, the expansion during the last year "appears to have been undergoing a transition to a more moderate and sustainable pace," he advised at a conference at The Levy Economics Institute of Bard College in Annandale-on-Hudson, New York. But the jig is not yet up, he suggested. "Looking ahead," Mishkin said, "the most likely outcome for the coming quarters is, in my judgment, a continued moderate rate of economic expansion...."
How then does one square Mishkin's modestly upbeat forecast with the fact that the yield curve remains inverted by more than a trivial amount? As of Friday's close, the benchmark 10-year Treasury yield was 4.67%, or nearly 60 basis points below the Fed funds rate of 5.25%.
Historically, there's been reason to think that an inverted yield curve portended recession. In fact, some are expecting no less. But rules of thumb that worked in the past are subject to reinterpretation, if not dismissal in the complicated globalized economic paradigm of the 21st century.
In fact, if the inverted yield curve is a warning sign, there's scant evidence that equity investors are taking heed. They may or may not be accurate, but no one can doubt their preference for optimism. Buying, in short, remains the prevailing mood in the stock market. The S&P 500 on Friday rose to a new post-2000 record. At this rate, a new all-time record is not beyond the pale, with the index now less than 5% under its former peak set in the halcyon days of early 2000.
Transition is a constant in the capital markets, but it's never clear what constitutes prudent thinking when points of substantial transformation reign. What worked in the past is of questionable value today, but beyond that there is wide debate about how to reinterpret market signals.
At least we can agree that something's changed when it comes to the relationship of short and long rates. As Daniel Thornton of the St. Louis Fed points out in the May issue of the bank's Monetary Trends, the yield curve has been behaving strangely of late, as the chart from Thornton's essay (reproduced below) shows. Clearly, the tendency of Fed funds and the 10-year yield to move in tandem has been fading in the 21st century.
Source: St. Louis Fed
But while it's easy to document the departure from historical norm, deciding what it means, including its causes and the investment implications, is something else. "The reason for this marked change in the behavior of these rates is a topic for further research," Thornton writes.
That won't satisfy investors in the here and now, but interpreting revolutions in finance sometimes takes time. The caveat reminds us the Chinese historian in the late-20th century who was asked to interpret the meaning of the French Revolution. It's too early to tell, he replied.
April 20, 2007
THE MOMENTUM GAME
Perhaps the world's stock markets will merely slow down rather than suffer a glaring correction. That may be overly optimistic, but looking at the total returns for regions across the globe raises the prospect that a soft landing for equities is a possibility. One reason to think that a kinder, gentler correction may be in the offing is that liquidity is still high and there's an abundance of committed investing shops looking for bargains.
The combined assets in mutual funds, ETFs and hedge funds have never been greater. Such capital may be flighty when it comes to any particular corner of the securities markets or countries. But portfolios jammed with cash looking for a home aren't going anywhere, at least not any time soon. The explosion in professional investment management in all its various guises means that there's always of hungry investors. That may prove ill-advised in time, but the trend has been decades in the making and it won't evaporate over the next week, month or even year.
When markets correct, the glut of the world's professional money managers immediately start looking for bargains. That translates in serious buying power that springs to action on a global scale that's unprecedented. Yes, it's always unclear if funds will dive in one more time whenever the next financial cyclone hits. But market hiccups in recent years suggest there's an ongoing willingness to hunt for value, relative or absolute, whenever markets take a tumble.
Eventually, one or more of the major asset classes will suffer a large and sustained bear market. But the fact that such corrections of duration and magnitude have been missing in action for so long in just about everything suggests there's still plenty of momentum behind the buying urge. The trend will play itself eventually. Ignoring that fact may prove costly to investors overdosing on optimism. For the moment, however, the analysis may explain why higher prices are so prevalent and seem to come so easily in so much of the world.
The stock markets on the planet tell the story once again in 2007. Of the 52 nations in the S&P/Citigroup Global Equity Indices database, only three (Columbia, Taiwan and Russia) post losses this year through last night's close in dollar terms, with the biggest decline at a modest 5.3% loss. The remaining 49 national markets in the list are up, quite often by substantial amounts. The best performing market is Peru, which has climbed nearly 50% in 2007 through April 19.
In broader terms, the gains are impressive too, as our chart below shows. The S&P/Citigroup developed world index is up 6.8% so far this year, while emerging markets have climbed 7.2%. Regionally, the Mideast and Africa index is the star regional performer, advancing nearly 16.8% year to date. The laggard is Emerging Europe.
Meanwhile, the U.S. gain is middling, at best, relative to markets around the world. Nonetheless, the 4.8% climb for domestic stocks is nothing to sneeze at, considering that we're not even halfway through the year and the long-term performance of U.S. equities is only slightly more than 10% annualized.
There's a hefty pile of academic research suggesting that the two leading factors driving returns (for good or ill) in managed equity portfolios are price momentum (up and down) and valuations (expensive and inexpensive). Clearly, momentum remains the dominant factor of late. The general perception is that there's more gold in them 'thar hills by way of choosing securities and markets based on the expectation of higher prices, as opposed to an attractive valuations. Eventually, the other factor will return to the fore. But for now, there's been little immediate gratification born of fighting the crowd. Buying on dips has a large and growing constituency. Only when the last investor embraces momentum will it be time to sell in earnest.
April 17, 2007
WET & TIRED
The Capital Spectator will be on holiday this week. A forced holiday, that is. In fact, the time off will be nothing close to a holiday. The storm that hit the Northeast on Sunday left your editor with about six inches of water in the basement. The cleanup, as any victim of flooding knows, is time consuming, among other things. In short, Mother Nature trumps Mr. Market this week for yours truly. Hopefully, next week we'll return to what passes for normal on these digital pages. Meanwhile, stay dry.
April 13, 2007
FRESH NUMBERS & OLD QUESTIONS
Like so many economic reports these days, this morning's update on producer prices for March is open to interpretation.
Depending on one's capacity for optimism, or the lack thereof, the latest gauge of inflation represents either a reprieve from anxiety, or another reason to worry.
The good news is that wholesale prices rose 1% last month. Although that's uncomfortably high, it's down a bit from February's 1.3% pace. Meanwhile, core PPI (excluding energy and food) was unchanged in March and below the 0.2% rise that the consensus outlook was projecting.
The bad news is that the PPI has climbed by 3.1% for the year through March. That's far below the 12-month rolling peak in recent years, but it's still too high to allow the Federal Reserve to focus exclusively on promoting economic growth in its monetary policy. "This certainly doesn't let the Fed off the hook by any means,'' Gina Martin, an economist at Wachovia Corp., told Bloomberg News. Inflation doesn't seem to be rising, but neither is it falling, she explained. That's a concern because inflation is "stubbornly staying high."
Energy prices led the way for upward prices momentum in the PPI last month. The 3.6% climb in energy costs at the wholesale level was the highest since last November. If energy prices fall in coming months, PPI may reap the benefits, which will be all the sweeter considering the core PPI appears contained for the moment.
Corroboration or repudiation for such thinking will come next Tuesday, when consumer prices for March are released. For what it's worth, the consensus estimate calls for a slight increase in top-line CPI to 0.7% from 0.6% previously with core CPI coming in at 0.2% for the second month running, according to Briefing.com.
Clarity on inflation is coming, but it's not here yet. Indeed, the bond market at mid-morning today appears to be taking a wait-and-see attitude. The 10-year Treasury yield is virtually unchanged from yesteday's close. Over in Fed funds futures trading, there's not much conviction for change in the near future other than for the status quo of 5.25%.
Investing in the 21st century enjoys a reputation for rapid trading, second-by-second analysis and the ability to move billions of dollars at the push of a button. But economic numbers, and the associated trends, can still dribble out at a snail's pace. As a result, the inflation outlook remains clouded and so there's still a strong incentive for cautious types to sit on overweight cash positions and wait for yet another round of data releases.
April 12, 2007
The Federal Reserve yesterday released the minutes of its March 20-21 FOMC meeting and confirmed the worst-kept secret in finance and economics: inflation's still a problem. Or a concern. Or something.
Anyone who's taken the time to look at the numbers dutifully released by the government each month already knows that there's reason to wonder if the price of money might rise again to fight any resurgence of the dark enemies of price stability. Notably, the core CPI (which excludes food and energy) shows no sign of moderating.
For good or ill, the Fed pays close attention to core CPI, and so the future path of interest rates may very well be determined by this inflation gauge. With that in mind, over the 12 months through February, core CPI rose by 2.7%. Not only is that near the highest level in years, it's also well above the Fed's comfort zone. "On a twelve-month-change basis," the Fed minutes advised, "core CPI inflation in February was considerably above its pace a year earlier, largely because of a sharp acceleration in shelter rents over the past year."
To be sure, the minutes also remind that the Fed hasn't lost all hope that core inflation will moderate. Still, reasonable minds might conclude that such hope seems to be fading a bit in the halls of monetary power. Consider, for instance, this excerpt from the minutes:
…the prevailing level of inflation remained uncomfortably high, and the latest information cast some doubt on whether core inflation was on the expected downward path. Most participants continued to expect that core inflation would slow gradually, but the recent readings on inflation and productivity growth, along with higher energy prices, had increased the odds that inflation would fail to moderate as expected; that risk remained the Committee’s predominant concern.
For some observers, the Fed's mixed reactions about inflation are unsettling. "This is the most inconsistent piece of communication we have seen under the new Fed chairman," David Jones, head of DMJ Advisors, a consultancy, told AP via BusinessWeek.com. "I think there is a big fight going on inside the Fed between officials who are more worried about inflation and those more concerned about growth."
At the moment, the central bank may be compelled to err on the side of fighting inflation. That, at least, was the message from one Fed head yesterday. "If inflation does not moderate, I believe additional firming may be needed," Richmond Federal Reserve Bank President Jeffrey Lacker said, according to Reuters.
Nonetheless, there wasn't enough conviction to materially change the outlook by way of Fed funds futures. Although sellers took a toll in some contracts, by and large the market still expects no change in Fed funds for the foreseeable future.
As for the FOMC, there appear to be two prevailing strains of thought circulating. Some members are clearly worried about inflation; others are still hopeful that pricing pressures will fade without any further tightening from the Fed. Investors can decide which outlook looks more compelling.
Mr. Bernanke has the power to clarify the central bank's position, of course, although he seems reluctant to make definitive statements. That's hardly surprising, given the Fed's history of warm and fuzzy public pronouncements. Nonetheless, occupying the gray zone carries elevated risks at this delicate juncture in the economic cycle.
April 11, 2007
The S&P 500 may be rocked with corrections from time to time, but they never endure, or so recent history shows. The S&P closed yesterday at less than 1% under its post-2000 high. So far this year, the S&P 500 is up 2.6%. For the past 12 months, the index has climbed 13.9%. If price is taken at face value, optimism continues to dominate the world of equities trading.
How does one square that with the news that earnings growth is decelerating? As The New York Times reported over the weekend, S&P 500 earnings are no longer rising at a double-digit rate, as they were previously in recent years. Earnings for the index "are expected to grow by only 3.3 percent in the first quarter of 2007, according to Thomson Financial," the Times advised. "This represents a huge drop in expectations, as Wall Street analysts at the start of this year were expecting a first-quarter growth rate of 8.7 percent."
Perhaps it'll be a sign of some relevance if the index makes a new high for the post-2000 era, although there's reason to wonder if that's imminent. "I think we're all anticipating the earnings season," Tim Hartzell, chief investment officer at Kanaly Trust Co., told AP. "I think everyone is going to wait on their heels and see how the numbers are going to come through."
Of course, if the numbers don't astonish like they used to, Mr. Market may be inclined to grade on a curve. "Investors have kind of lowered the bar'' for first-quarter earnings, "making it easier for stocks to outperform,'' Christopher Johnson, chief investment strategist at Johnson Research Group, told Bloomberg News. "The numbers that we see coming in aren't much worse than what we saw last quarter. We could see some bright spots.''
Among those bright spots on a sector basis, and in relative terms, are the utilities and telecom corners of the S&P 500. In fact, those are the only sectors forecast to post an improvement over the previous quarter, or so wrote Dirk Van Dijk of Zacks Research. But as reasons to cheer go, the details don't necessarily inspire. Utilities' Q1 earnings will advance 6.9%, Zacks predicts. Yes, that's a hefty upgrade from the big zero that defined the earnings change for utilities in the fourth quarter. On the other hand, 6.9% is still below the anticipated 7.1% rise for S&P 500 earnings overall.
The telecom story is even less encouraging. Zacks said that telecom earnings will be unchanged in Q1. Of course, that's better than -10.7% logged in last year's fourth quarter. As bullish news goes, this is thin gruel.
Perhaps the optimists will find greener pastures by focusing on individual names for the time being. Alcoa, to cite the current favorite, charmed everyone by beating the consensus earnings prediction and reporting a 9% rise in profits.
But how many Alcoas are poised to bloom? Perhaps fewer than prudence suggests. Zacks' Van Dijk certainly pulled no punches when he wrote: "Looking at the full expectations for the quarter, we see that a substantial slowdown in year-over-year earnings growth is expected in the first quarter, almost across the board."
So, while the S&P 500 remains less than 1% below its recent high, forging a new peak may take a bit longer than the recent bullish momentum suggests. But for the moment, at least, we still have Alcoa.
April 9, 2007
THE SEARCH CONTINUES
Rebalancing can't save the world, but perhaps it can bring salvation to portfolios in the long run. History certainly suggests as much.
By opportunistically selling asset classes that have rallied and buying those that have lagged, a disciplined approach to rebalancing a broadly diversified portfolio of beta may best deal in money management. The reason, as Charlie Ellis famously counseled, is that the best way to win over time is by not losing.
With that in mind, what opportunities currently avail themselves for those inclined toward rebalancing? As our table below suggests, the pickings remain slim based on recent history. Investors looking for obvious candidates to sell based on year-to-date returns through April 6 will note the leader as MSCI EAFE, represented here by the iShares ETF tracking the index. Year to date, the ETF has climbed 6.2%. It's debatable whether that's enough of a run to warrant the associated trading costs and taxes that would come from paring the position and reallocating elsewhere.
But if EAFE's run in 2007 is a gray area, so too are the other asset classes, all of which have rallied by lesser amounts. In fact, the laggard so far this year is cash, represented here by Fidelity Ultra-Short. That's hardly surprising, although it suggests that the best opportunity for redeployment of capital still resides in the lowest-risk corner of the asset class pool.
Might there be more attractive quarry when profiling performance on a 12-month trailing basis? Yes and no. Yes, in the sense that the dispersion of returns is wider, which theoretically implies more rebalancing opportunities. As the 12-month column above shows, the distance between the top and bottom performer is significant. But here's where the analysis gets tricky. The laggard is commodities, albeit a measure of commodities that's energy heavy. Oppenheimer Commodity (which tracks Goldman Sachs Commodity Index) has shed 9% over the past year through Friday. Of course, much of the stumble came last year. More recently, the fund's been rebounding, as befits an oil-dependent portfolio.
For those who prefer their commodity indices more broadly defined, note that there's no red ink in either the trailing 12-month or year-to-date periods for a competing product. Witness the 9.1% gain in the past year in the Credit Suisse Commodity, which uses Dow Jones AIG Commodity Index as its bogey. The fund, in short, is the polar opposite of the Oppenheimer offering in terms of rebalancing opportunity.
While investors have reason to argue if it's time to buy or sell commodities overall, the scorecard is clearer when it comes to REITs. As an asset class, REITs have been nothing less than stellar performers. More of the same may be coming, or not. What's clear, however, is that over the past year, REITs have sharply outdistanced the other asset classes. As a result, quant-oriented rebalancers will recognize REITs as the leading contender for paring allocations.
But that leaves the challenge: Where to redeploy? Yes, it's easy to identify the winners, in either relative or absolute terms. Alas, there are no obvious losers, and so redeploying to cash remains the primary nominee on the receiving end. There are, however, limits to everything. For those with an already-heavy cash weighting, those limits are being tested. Indeed, long-term success can look foolish and unappealing in the short term, proving once again that there truly is no such thing as a free lunch.
April 6, 2007
GOOD FRIDAY AND OPEN QUESTIONS
If an employment report is released in the forest, does it make an impact?
Today's update on job creation for March arrived when much of Wall Street is on holiday, courtesy of Good Friday. The stock market is closed in the U.S., although government bond trading is open for an abbreviated session. Whether or not anyone's paying attention, the Labor Department advised that nonfarm payrolls jumped by 180,000. Meanwhile, unemployment dropped to 4.4%, the lowest since last October.
Does the number of new jobs created inspire confidence on the economy? Fear of inflation? Both? Neither? Whatever the answer, it's certainly an improvement over February's tally, which rolled in at a gain of only 113,000 new jobs. In fact, March's rise in payrolls by 180,000 is the highest since December's 226,000. But even a determined optimist has to admit that last month's pace of job creation is no better than middling relative to recent history, as our chart below shows.
Our conclusion doesn't change when we consider the longer perspective for job growth on a 12-month rolling percentage basis. As the second graph shows, the pace of minting employment opportunities remains dramatically improved from the 2002-04 period, but the economy's now off its peak from the gains of more recent vintage.
So, what do investors think of the news? We'll have to wait until Monday for reactions from the equity realm. Meanwhile, the truncated trading day in the 10-year Treasury, as of mid-morning, revealed a touch of anxiety, with the yield rising to 4.75% from yesterday's close of 4.67%.
And so, as we head into the weekend, there's fresh questions to ponder, starting with: Will Good Friday end up being a good Friday for the bulls next week? A robust answer will have to wait. In the meantime, off-exchange speculation reigns supreme this weekend.
April 5, 2007
GRAB A SEAT IN THE WAITING ROOM AND SETTLE IN
If you asked institutional investors what they feared most as a possible threat to the U.S. equity market, how do you think they'd reply? Terrorism? Real estate fallout? Consumer debt? In fact, the leading source of worry among pension funds and other institutional overseers of money is inflation.
That, at least, is the result of Frank Russell Co.'s March survey of 209 institutional investors. Twenty-two percent of the managers ranked inflation as the greatest threat to the equity market, followed by 20% citing geopolitical instability as the primary risk and 15% pointing to a softening real estate market. Meanwhile, nearly two-thirds (64%) of the managers said that domestic stocks generally were fairly valued and 13% thought it's overvalued.
The broader context for such thinking is an equity market that seems intent on moving higher once more in an effort to reach its previous summit set back in the heady days of March 2000. Yes, the bulls seem to have regained the upper hand in recent trading sessions and one should be wary of underestimating momentum, which has been biased toward the upside for several years now. But there's enough doubt about the economy to keep the debate bubbling and the bears hopeful.
The inflation issue remains an open question too, as the latest Russell survey suggests. But if institutional money managers are worried about general price trends, there's not much follow-through in the bond market. The yield on the 10-year Treasury continues to trade in a range. Yesterday's close of 4.65% represents a middling level for 2007 so far.
Over in the trading pits for Fed funds futures, all's quiet as well. Looking out to the August contract, the market expects that the current Fed funds rate of 5.25% will hold until at least Labor Day.
From our vantage, it all looks like a standoff between those who think inflation's still a threat vs. investors expecting the economy will soften enough to nip any inflationary momentum in the bud. One side will eventually win, leaving the other to retreat and tend to the pain inflicted by financial loss and wounded ego. In the meantime, the back and forth continues. One day the word recession is in favor; the next brings inflation. There are even some who worry that both will arrive, delivering the dreaded stagflation.
The determining factor will be the data, of course, which continues to roll in. At some point the accumulating trend will favor one or the other side. Or, perhaps one economic report will be so dramatic as to clarify the situation once and for all.
Lesser mortals such as ourselves prefer to watch and wait, minimizing allocations to higher risk asset classes while keeping cash at the ready to exploit the fallen angels of the future. Yes, it could be a long wait. Of course, we're being paid to wait, with cash continuing to pay north of 5%. And with clues that the Fed's not about to cut rates any time soon, we fully expect that the waiting room will become increasingly crowded as the year progresses.
April 4, 2007
ANOTHER WARNING FROM MONEY SUPPLY DATA?
Money supply gets no respect, but that doesn't stop it from setting new, albeit minor milestones in the 21st century.
The latest comes by way of weekly M2 money-supply numbers through March 19, the most recent posted by the Federal Reserve. Based on those stats, M2 grew by 6.1% over the year-earlier amount. As our chart below shows, that beats the previous 52-week rolling peak of 6.0% set back in January 2005.
More importantly, M2's expansion rate continues to climb. The rise this year has been steady, jumping from under 4% at last year's close to the recent 6%-plus level. The trend may or may not be temporary, but it's increasingly clear that the Fed has been deliberately elevating M2 in a meaningful way.
Context, of course, counts for something. With that in mind one might ask, How fast is the current 6.1%? For perspective, consider that the economy's growing at a nominal rate (i.e., at the current dollar rate) of 4.1%, based on the annualized change in current-dollar GDP in last year's fourth quarter, according to the Bureau of Labor Statistics.
There are any number of explanations (some encouraging, some less so) for why money supply's rate of increase continues to move higher. Anxious types, such as your editor, worry that the reason is related to the central bank's inclination to provide aid and comfort to a slowing economy. But the aid and comfort appears to be coming in the form of increasing M2 at rate above and beyond the pace of economic expansion. You can only indulge in that strategy for so long before you run the risk of stoking inflation's fires.
Perhaps the M2 pace of change will turn down. Perhaps the economy's expansion will pick up a head of steam. Perhaps Bernanke and company will dispense monetary medicine in exactly the right dosage that satisfies growth while keeping inflation at bay. But for now, we reserve the right to stay mildly skeptical.
April 3, 2007
THE NUMBERS SPEAK, BUT WHAT ARE THEY SAYING?
Attempts at summarizing an $11 trillion economy are almost certainly doomed to disappoint, but the prospect of failure never stopped your editor from reviewing the numbers to see what's cookin'.
With that qualification out of the way, we turn to the economic numbers in the hope (however remote) of finding some crumbs of insight into where we're headed. A smattering of quantitative morsels can be found in the table below. Drawing on numbers posted as of February 2007, there's reason to think that the economy may have some growth left in it after all. In particular, note the robust gain in personal consumption expenditures for both February and for the past year. The death of Joe Sixpack's inclination and ability to keep spending more has been predicted in some quarters, but to date there's no sign of it.
There is, however, reason to worry that the housing correction will take a toll on the wider economy, as the red ink for new home sales and housing starts suggests. But all's not lost yet in this corner. The rebound in starts in February (up by 9%) extends some hope that upside surprises are still possible.
In fact, as our thoroughly unscientific analysis implies, the recent past carries reason for optimism on the economic trend overall. Based on our limited sampling of numbers, February's change in the economic reports was modestly higher by an average of 0.2%, as our table above shows. Of course, that compares to an average 12-month dip in the same numbers by 0.5%.
The question then is a familiar one: Are we in the midst of a dead-cat bounce or the start of a second economic wind? Alas, the answer is also one that you've heard before, although that won't make it any more satisfying: It all depends on future economic reports.
April 2, 2007
TIPS & TAXES
Among the various financial worries that afflict yours truly these days are the double-edged threat of inflation and taxes. One attacks from the left, the other from the right. Ideally, there are some crumbs left over after these two demons have had their way with an otherwise profitable investment. But there are no guarantees, especially for taxable accounts holding asset classes that aren't likely to deliver stellar gains in any given year, even under the best of circumstances.
In particular, we're thinking of inflation-indexed Treasuries, or TIPS. In concept, TIPS are great. Owning the securities allows for the locking in of a real, or inflation-adjusted yield for the life of the bond. The problem is one of how the government taxes TIPS. If inflation jumps sharply, so too will the tax bill that year. That's because the interest payment on TIPS, along with any rise in principal (triggered by a rise in the consumer price index), is treated as income. The higher principal is taxable in the year it occurred, even though it won't be realized until the bond matures or the investor sells--phantom income, as it's known.
For that reason, many investors hold TIPS and TIPS-focused mutual funds in tax-deferred accounts. But for some, particularly those lucky enough to be in the high-net-worth category, a fair chunk of the portfolio may be taxable. For investors considering owning TIPS in a taxable account, there are some recent innovations to consider, such as the JPMorgan Tax Aware Real Return mutual fund.
Minimizing the tax man's bite and hedging inflation via TIPS in taxable accounts are also among the specialties of the bond shop Samson Capital Advisors. Your editor recently interviewed one the principals on the issue of TIPS and taxes. The Q&A appears in the April issue of Wealth Manager. And now, through the miracle of the Internet, we also offer a copy of the conversation here. Death and taxes may be inevitable, but delaying both ranks fairly high as one of the more productive uses of time. For some insight into the latter on the matter of TIPS, please read on....