May 31, 2011
Three Economic Reports, Three More Reasons To Worry
A trio of economic reports released this morning bring fresh clues about the outlook for the macro trend, but all three offer only more reason to wonder if the economy can maintain positive momentum in the months ahead.
Let’s start with the S&P Case-Shiller home price index. There was no great surprise here in learning that prices are still falling. The 10-city index dropped 0.1% for March and the 20-city index was down by 0.2%. More discouraging is the fact that the trend remains deeply negative. As the chart below shows, the brief bounce has long since faded and prices continue to slump on a year-over-year basis.
“The rebound in prices seen in 2009 and 2010 was largely due to the first-time home buyers tax credit,” says David Blitzer, chairman of the Index Committee at S&P Indices, in a press release that accompanied the update. “Excluding the results of that policy, there has been no recovery or even stabilization in home prices during or after the recent recession. Further, while last year saw signs of an economic recovery, the most recent data do not point to renewed gains.”
The news isn’t any better in the Conference Board’s consumer confidence index for May. A sharp drop in the index suggests that consumers have turned gloomy once more. “Consumers are considerably more apprehensive about future business and labor market conditions as well as their income prospects,” says Lynn Franco, director of The Conference Board Consumer Research Center, in a prepared statement. “Inflation concerns, which had eased last month, have picked up once again. On the other hand, consumers’ assessment of current conditions declined only modestly, suggesting no significant pickup or deterioration in the pace of growth.”
Meanwhile, a big drop in a measure of business conditions for the Chicago region adds to the anxiety. A hefty drop in the monthly pace of growth for new orders was the culprit. Although the Chicago Purchasing Managers Index is still at levels associated with expansion, the fact that new orders—a leading indicator—slowed the most in several years isn’t encouraging.
The good news is that the risk of a new recession is still quite low, based on a broad reading of the economic profile. The bigger threat is that the expansion slows by more than a little. What could tip that outlook into something darker? We may find out later this week as the next round of numbers hits the street. First up is tomorrow’s update on the ISM Manufacturing Index, followed by jobless claims on Thursday, and the May nonfarm payrolls update on Friday.
The jobs report in particular is critical, now more than ever. The consensus forecast anticipates a modestly lower pace of growth for private nonfarm payrolls for May vs. April, but nothing that suggests a new recession is near. But all bets are off if there’s a big disappointment.
"This is a delicate moment for the global economy, and the crisis is not over until our economies are creating enough jobs again," says Angel Gurria, secretary general of the Paris-based Organisation for Economic Cooperation and Development (OECD).
Strategic Briefing | 5.31.2011 | U.S. Housing Market
Home Prices in U.S. Probably Kept Falling as Housing Absent From Recovery
Bloomberg | May 31
U.S. home prices probably slumped in March by the most in 16 months, indicating residential real estate will keep weighing on the expansion, economists said before a report today... “Weak demand and a deluge of discounted sales of distressed properties have weighed significantly on prices,” said Aaron Smith, a senior economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. “It’s hard to be enthusiastic about the economy’s prospects as long as house prices are falling.” A backlog of foreclosures poised to reach the market means prices may stay depressed, dissuading builders from taking on new-home construction projects.
Housing Index Is Expected to Show a New Low in Prices
The New York Times | May 30
Housing is locked in a downward spiral, industry analysts say, not only because so many people are blocked from the market — being unemployed, in foreclosure or trapped in homes that are worth less than the mortgage — but because even those who are solvent are opting out. “The emotional scars left by the collapse are changing the American psyche,” said Pete Flint, chief executive of the housing Web site Trulia. “There was a time when owning a home was a symbol you had made it. Now it’s O.K. not to own.”
To Shore Up the Recovery, Help Housing
Moody's Analytics | May 25
The gloom in the housing and mortgagemarkets notwithstanding, there are reasons to be optimistic that housing’s long slide will come to an end soon. While a mountain of distressed property remains to be sold, investor demand appears strong. Prices have fallen enough to allow investors to profitably rent out these homes until the market recovers. Rental vacancy rates have fallen meaningfully over thepast year, suggesting that new construction is slow enough to let builders work down the still-considerable number of excess vacant homes.
Federal government guilty of hurting housing market by guaranteeing mortgages, inflating home values
NY Daily News | May 31
bIt seems logical to think that government should not be underwriting everyone's mortgages, but since the financial meltdown, things have actually gotten worse, not better. With banks nervous about lending and with tens of millions of homeowners underwater, more than 90% of all mortgages are being guaranteed by the government - and that means by you and me. Further, in the past Fannie and Freddie were only quasi-government agencies. But now that we have bailed them out they are actually part of the government - which means that we, the taxpayers, are financing more than 90% of all mortgages and covering the losses of anyone who is underwater. With the government guaranteeing mortgages, home values have become artificially inflated. You may think home prices are attractive, but if the government stopped guaranteeing 90% of all mortgages, they would be lower.
US has 14.3m vacant year-round homes and home ownership has dropped to 1998 levels
Finfacts | May 31
Pending home sales fell in April with regional variations following increases in February and March, with unusual weather and economic softness adding to ongoing problems that are hobbling a recovery, according to the National Association of Realtors (NAR). The Pending Home Sales Index, a forward-looking indicator based on contract signings with completion expected within 2 months of signing, dropped 11.6% to 81.9 in April from a downwardly revised 92.6 in March. The index is 26.5% below a cyclical peak of 111.5 in April 2010 when buyers were rushing to beat the contract deadline for the home buyer tax credit.
Investors optimistic about housing market, survey says
The Arizona Republic | May 25
Investors in the housing market remain bullish about their chances for turning a profit, according to results of a survey issued today by online real-estate firm Move Inc., based in Campbell, Calif. Among their reasons to be optimistic were weak competition from traditional homebuyers, strong demand for single-family rental properties and the relatively low cost of buying and fixing up homes. However, the survey's results also point to some perceived weak spots in the market, including stagnant resale prices and difficulty obtaining purchase loans.
May 28, 2011
Book Bits For Saturday: 5.28.2011
● I Am John Galt: Today's Heroic Innovators Building the World and the Villainous Parasites Destroying It
Summary via publisher, Wiley
Inspired by Ayn Rand's characters in Atlas Shrugged and The Fountainhead, penetrating profiles of both the innovators who move our world forward and those who seek to destroy the achievement of others. John Galt, the fictional character from Ayn Rand's bestselling novel, Atlas Shrugged, has come to embody the individualist capitalist who acts in his own enlightened self interest, and in doing so lifts the world around him. Some of today's most successful CEOs, journalists, sports figures, actors, and thinkers have led their lives according to Galt's (i.e., Rand's) philosophy. Now, in I Am John Galt, these inspiring stories are gathered with the keen insight and analysis of well-known market commentator Donald Luskin and business writer Andrew Greta. Filled with exclusive interviews, profiles, and analyses of leading financial, business, and artistic stars who have based their lives, and careers, on the philosophy of the perennially popular Ayn Rand, this book both inspires and enlightens. On the other side are Rand's arch villains the power-seekers, parasites, and lunatics who would destroy that which the creators and builders make. Who are today's anti-heroes, fighting the creativity of the innovators?
● Aftermath: A New Global Economic Order? (Possible Futures)
Edited By Craig Calhoun and Georgi Derluguian
Summary via publisher, NYU Press
The global financial crisis showed deep problems with mainstream economic predictions. At the same time, it showed the vulnerability of the world’s richest countries and the enormous potential of some poorer ones. China, India, Brazil and other countries are growing faster than Europe or America and they have weathered the crisis better. Will they be new world leaders? And is their growth due to following conventional economic guidelines or instead to strong state leadership and sometimes protectionism? These issues are basic not only to the question of which countries will grow in coming decades but to likely conflicts over global trade policy, currency standards, and economic cooperation.
● Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present
By Jeff Madrick
Review via Publishers Weekly
A number of books are clear about the causes of the recession, none more so than The Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present, in which author and journalist Jeffrey Madrick argues that today's economic problems, including a high concentration of wealth, have been building for 40 years. Madrick begins with one-time Citicorp head Walter Wriston's successful deregulation fight and examines the actions of some of the most powerful economic players of the times, including Milton Friedman, Ivan Boesky, Michael Milken, Jack Welch, and Alan Greenspan. Delving into the underlying causes of the 2008 financial crisis is at the heart of Brendan Moynihan's Financial Origami: How the Wall Street Model Broke. Using the Japanese paper art as a metaphor, Moynihan shows how Wall Street's financial engineering models morphed from effective tools during stable times to the cause of financial destruction when times turned tougher.
● What's Next?: Unconventional Wisdom on the Future of the World Economy
Edited by David Hale and Lyric Hughes Hale
Summary via publisher, Yale University Press
The world spins in economic turmoil, and who can tell what will happen next? Cold numbers and simple statistical projections don't take into account social, financial, or political factors that can dramatically alter the economic course of a nation or a region. In this unique book, more than twenty leading economists and experts render thorough, rigorously researched prognoses for the world's major economies over the next five years. Factoring in such varied issues as the price of oil, the strength of the U.S. dollar, geopolitics, tax policies, and new developments in investment decision making, the contributors ground their predictions in the realities of current events, political conditions, and the health of financial institutions in each national economy.
● What You Need to Know about Economics
By George Buckley and Sumeet Desai
Summary via publisher, Wiley
Economics Matters. But with confusing things like GDP and interest rates, it’s often hard to get you head around. So What do you really need to know about economics? Find out:
•What economic growth is and why it matters
•How inflation happens
•How jobs are created and lost
•How the property market works
•What central banks do and how it affects the rest of us
•The impact of government spending on the economy
What You Need to Know About Economics cuts through the theory to help you to do your job and understand the world around you better.
May 27, 2011
Consumer Income & Spending Rise In April, But Warning Signs Persist
Disposable personal income and personal consumption spending rose last month, the U.S. Bureau of Economic Analysis reports. But after adjusting for inflation, the nominal rise fades to zero for income and posts only the smallest of increases for consumption. As such, today’s income and spending report is likely to give bears and bulls something to chew on.
One trend that bears watching is the growing gap between spending and income when measured on a rolling 12-month percentage-change basis, as the chart below shows. This can’t last, and so it implies that either spending must slow or income must rise, or perhaps a bit of both.
Private-sector wages are, in fact, continuing to rise at a fairly strong pace in nominal terms, advancing by 0.5% last month--the fastest rate since last August. On an annual basis, private-sector wages are higher by 4.1%. That’s down slightly from the annual pace of February and March, but it’s hardly indicative of a hefty downshift.
But that doesn’t let us off the hook just yet. Another way to look at income and consumption is on an inflation-adjusted (real) basis for rolling 12-month periods, which has a fairly good history of dropping clues about major turning points in the economic cycle. Unfortunately, there’s some reason for anxiety in looking at these numbers, as the second chart below indicates. In particular, note that real average hourly earnings are now slipping, if only slightly, on a year-over-year basis. The last time that happened was March 2010, just before the economy hit a rough patch. In other words, the divergence between income and spending is far more pronounced on a real basis than it is in nominal terms. Quite simply, that's not encouraging. The question is whether the trend in real wages will continue falling?
“The recovery still lacks vigor,” Aaron Smith, a senior economist at Moody’s Analytics, tells Bloomberg. “Incomes have struggled to keep pace with inflation recently.”
May 26, 2011
New Jobless Claims Rise By 10,000 Last Week
Today’s update on initial jobless claims suggests that the recovery is at risk of stalling. Indeed, the April surge in new filings for unemployment benefits warned as much. Although the surge has moderated this month, the data appears stuck in a range that implies weak economic growth at best.
New claims rose last week by 10,000 to a seasonally adjusted 424,000. That’s too high to inspire much confidence that the economic reports in the weeks ahead are poised to impress on the upside. More disturbing is the recent increase in the four-week moving average of new claims. The message here is that the ranks of the newly unemployed have popped higher and that this change for the worse is more than statistical noise.
The numbers haven’t surged to a degree that leaves no possibility for thinking positively. For what it’s worth, the data suggests to your editor that the economy may slow but still manage to avoid a recession. But even that slight bit of optimism is subject to change as new numbers roll in. We’re at a critical juncture—again and small shifts in sentiment and economic trends can unleash big changes.
A cleaner look at what’s at stake is available by reviewing jobless claims on a rolling 12-month percentage-change basis. Because this is a year-over-year comparison, we can ignore the seasonal adjustment and focus on the raw numbers as reported. The benefit of looking at new applications for unemployment benefits in this context is that it strips out any short-term volatility, which tends to be quite high for this series.
The second chart below presents the data in this way and as you can see there’s been a upward trend for about a year. In other words, the fall in jobless claims is lessening. That’s not necessarily surprising. As the post-recession expansion matures, the pace of decline in jobless claims is all but certain to slow relative to the year-earlier figures. But at some point the trend slows too much and reflects an economy that’s at risk of slipping into a new recession. No one’s really sure where that point of no return is, but we’re a lot closer to it now than we were a few months ago, based on the unadjusted annual change in new claims.
The fundamental issue is, of course, jobs. If the 12-month trend in jobless claims continues to inch higher in the weeks ahead, it will cast a dark cloud over the prospects for the labor market, which is at the core of evaluating where the economy's headed. Indeed, look at the chart above and take note that an early warning of the approaching Great Recession was reflected in the steadily rising 12-month percentage change in new claims. By mid-2008, this series was sending a powerful sign that a new recession was virtually assured by consistently positing year-over-year gains. Fortunately, we’re still a long way from such levels. Indeed, the latest numbers reveal that jobless claims are still falling on an annual basis--by more than 9% as of last week. The question is whether this annual measure will continue to deliver encouragement? The margin of comfort is thinning quickly. It doesn’t help that the trend over the past year doesn’t appear friendly, or that the appetite for risk-free assets is on the march again. The influx of assets into the 10-year Treasury, for example, is such that the yield has fallen to 3.13%, or the lowest since last December.
Perhaps the strongest piece of statistical optimism to counter the recent trend in new jobless claims is the fact that nonfarm payrolls have been improving lately. Indeed, job growth in April was the strongest since the Great Recession ended in June 2009, as per NBER. It’s hard to reconcile last month’s encouraging rise in job creation with the recent numbers in new claims. It’s a divergence that won’t continue for long, however. One metric or the other will give way. Any bets as to which one?
The May employment report is scheduled for release next week (Friday, June 3), and so this much is clear: There won’t be a leg to stand on if the private nonfarm payrolls number disappoints in a big way. In fact, nothing short of a large gain on the order of 250k-plus is likely to bring an antidote to the discouraging jobless claims reports in recent weeks.
"There is no doubt the economy has slowed. We will call the first half of 2011 as a soft patch," says Robert Dye, a senior economist at PNC Financial Services. But it’s too early to throw in the towel, he adds. "We should see growth accelerate in the second half in the 3.0 percent to 3.5 percent area."
If so, we’re likely to see some sign of improvement in the jobless claims numbers. For the moment, however, that’s still wishful thinking.
May 25, 2011
New Durable Goods Orders Tumble In April
New orders for durable goods suffered a hefty fall last month, dropping 3.6% in April on a seasonally adjusted basis, the Census Bureau reports. That’s the biggest monthly slide since last October’s 3.7% retreat. This isn’t news we want to hear right now, given renewed worries of an economic slowdown. What's more, there's no statistical hiding spot: April’s drop in new orders was broad based. But the trend is still positive on an annual basis, and that counts for something. Indeed, given the unusually high rate of recent gains on a rolling 12-month basis for new orders was destined to slow and so it's not terribly surprising to see a bit of red ink.
For the year through last month, new orders rose 5.3%, despite last month's drop. As the chart below reminds, that’s still a strong pace. It’s probably headed lower without a surge in economic activity in the months ahead. That seems unlikely, which implies that we should expect additional downshifts in the new orders.
Even if the pace softens further in the months ahead, there’s still a margin of safety for thinking positive vis-a-vis the 12-month trend. Anything north of 2% to 3% a year suggests that the risk of a new recession is still minimal. Nonetheless, there’ll be a fine line between returning to trend and a new warning signals that a bigger problem is brewing, and it won't necessarily be obvious where we stand in real time.
"It's another modestly disappointing data point in a long series of slightly disappointing data points that we've gotten in the last month," Fred Dickson, chief market strategist at D.A. Davidson & Co., tells Reuters. "[It's] not indicative of an economic downturn, just kind of paints a picture that the economy is in a momentary lull."
That’s a fair summary based on the information currently available. “Manufacturing is likely to moderate from the explosive pace of growth in the past few months,” opines Stephen Stanley, chief economist at Pierpont Securities, via Bloomberg. “Consumer demand and investment demand are both doing well right now.”
But there are several key economic reports scheduled for the remainder of the week, and so the possibility of an attitude adjustment can’t be dismissed. Tomorrow we learn if last week’s initial jobless claims behaved or not. The consensus forecast calls for slight improvement after the recent surge suggested something darker was lurking. The second GDP estimate for the first quarter arrives tomorrow as well, although expectations are roughly in line the initial weak 1.8% estimate. Not great, but that's old news that's already priced into the market. In addition, Friday brings word of personal income and spending for April, and economists are predicting a fairly strong rise, according to Briefing.com.
The chance for a relaxing holiday (Memorial Day) weekend in the U.S. may be in the cards after all, although it’s going to take some pretty encouraging numbers in the days ahead to reverse the anxiety unleashed by today’s durable goods report.
Strategic Briefing | 5.25.2011 | Will There Be A QE3?
QE3 Has Already Started
OilPrice.com | May 24
The new QE3 is the “RISK OFF” trade. QE2 ended up pouring $600 billion into stocks, commodities, oil, gold, and silver. Since April 29, the prospect of slowing economic growth has prompted this hot money to take flight and bail from these assets classes. Think of it as the same $600 billion stampeding into risky markets, doing a 180, and then stampeding right back out against. Where is all this money going? Into the Treasury bond market. We have in fact been in new bull market for bonds since February, taking the yield on the ten year Treasury down from 4.10% to 3.10%. If the current “RISK OFF” trade continues, or even accelerates, we could see ten year yields down to 2.0%-2.5% by the end of the summer.
Bernanke Will Be Forced To Do QE3
DailyCapitalist.com | May 22
The Fed is serious about freezing its balance sheet starting in June. They will continue to buy Treasurys as issues mature and are replaced. But, as Shostak points out, the momentum of money growth will slow down and that is the key to understanding what will then happen. If Treasury rates do not take off, then my assumption about domestic and foreign demand for Treasurys will be correct. If they do take off, it will be an indication of a shrinking money supply as Shostak points out which will lead to economic stagnation or even a market bust. On the other hand, I don’t believe the Fed will play “chicken” during an election year, and when things turn ugly they will announce QE3 and that will kick the can down the inflationary road. QE3 may be the last installment of this monetary madness.
Fed's Dudley: Bernanke Put High Bar On QE3 Adoption
The Wall Street Journal | May 19
Federal Reserve Bank of New York President William Dudley on Thursday said people shouldn't be concerned that massive levels of Fed-created bank reserves will cause an inflation surge down the road. "I don't think people should be concerned" about the reserves now parked on the Fed's balance sheet, the policymaker said. "We are going to make sure" they aren't the source of rising prices and, to ensure that, "we will exit in a timely way," he explained.
Outlook for S&P 500 and Economic Growth Cut: CNBC Survey
CNBC | May 24
Market participants now virtually rule out QE3 with 82 percent saying there will be no additional purchases after the current QE2 program ends in June. That’s up from 66 percent in the April survey.
The Case for More Monetary Elixir
Guggenheim Partners | May 19
While I acknowledge the potential for rising rates, I don’t think the expiration of QE2 is the catalyst that most believe it to be. In fact, I believe U.S. rates should remain range-bound at historically low levels for an extended period of time. I find it surprising how the majority of market watchers, lost in the obsession with QE2’s expiration, have so quickly dismissed the possibility of QE3.
Saxo Bank | May 20
The current Fed thinking is that QE2 will end in June and that the economy will continue to sail off into the sunset. But exactly when was the last time Bernanke and Co. Were right about the US economy? The most recent FOMC have the Fed spelling out how it will begin to reduce its balance sheet. But is this simply a replay of the end of QE1, when the Fed was discussing the mechanisms for an exit strategy like reverse repos and the like, only to launch QE2 within a few months as the US economy couldn’t live without its monetary heroin? The base scenario: the US economy will deteriorate again late this year or by early next and, though the hurdle will be very high for QE3, it won’t be any higher than a return above 10% in the unemployment rate and/or very slow growth or a recession, combined with bond yields at the long end moving uncomfortably high.
Puru Saxena, chief executive at Puru Saxena Wealth Management, discusses the prospects for QE3
CNBC | May 19
Puru Saxena, chief executive at Puru Saxena Wealth Management, says the recent sell-off in commodities is a perfect backdrop for QE3.
May 24, 2011
Is The Core Inflation Concept Rotten?
St. Louis Fed President James Bullard recently attacked the concept of core inflation, which excludes volatile food and energy prices. The "core is rotten," he argued in a speech last week. "One popular argument for focusing on core inflation is that core inflation is a good predictor of future headline inflation," he said. "I think this is wrongheaded, as well as wrong."
It’s fair to be skeptical of core inflation as a flawless predictor of future headline inflation. Nothing rises to that standard. It’s also prudent to recognize that there’s more than one way to measure core inflation. But to reject the idea entirely is going too far because it requires dismissing several decades of research and the historical record. Bullard obviously disagrees, as do other analysts, but such opinion is hardly airtight.
Still, it’s easy to see why there's so much fuss about core vs. headline inflation. After all, the man on the street must routinely pay for food and energy and so the idea that inflation should be measured without these essential commodities sounds crazy. Indeed, Bullard comes close to espousing a political view in rejecting core. "One immediate benefit of dropping the emphasis on core inflation would be to reconnect the Fed with households and businesses who know price changes when they see them," he noted. Reconnect? It's slightly dangerous to suggest that central banks should start considering what's popular rather than what's economically logical. Recognizing what’s practical for consumers isn’t necessarily enlightened when it comes to designing monetary policy.
Bullard’s charges against core inflation are hardly an obscure academic point since the Federal Reserve does pay quite a bit of attention to the notion of core for setting monetary policy. So when the president of one of the banks in the Fed system publicly dismisses the idea, it’s big news. The problem is that the basis for using core inflation didn’t arise in a vacuum. The focus on core has evolved via years of research that suggests that this narrower gauge inflation is a better predictor of headline inflation for the medium- to long-term future. A few of the many examples in the literature that favors core include:
"A Review of Core Inflation and an Evaluation of Its Measures" by Robert Rich and Charles Steindel (NY Fed staff report, 2005).
"A Simple Adaptive Measure of Core Inflation" by Timothy Cogley (Journal of Money, Credit and Banking, Feb. 2002)
"Comparing Measures of Core Inflation" by Todd Clark (Kansas City Fed Economic Review, 2nd Quarter 2001)
Bullard gave a passing nod to the body of research that supports core's role in monetary policy, but then he largely dismissed it on the basis of a few recent papers that suggest otherwise. Again, that’s a sign that there can and should be serious debate about the value of core, but it’s premature to reject it out of hand. Former Fed Governor Frederic Mishkin explained the reasoning a few years ago:
It does indeed make sense for central banks to emphasize headline inflation when determining the appropriate stance of monetary policy over the medium run, but policymakers also are right to emphasize core inflation when deciding how to adjust policy from meeting to meeting. Why? Because what central bankers are truly concerned with--both for the purposes of internal deliberations and for communications with the public--is the underlying rate of inflation going forward, and core inflation can be a useful proxy for that rate. Thus, focusing on core inflation can help prevent a central bank from responding too strongly to transitory movements in inflation.
Another former Fed governor, Larry Meyers, who now heads up Macroeconomic Advisers, made a similar case recently in a piece for the New York Times:
There are two fundamental measures of inflation: overall (or "headline") inflation and "core" inflation, which excludes food and energy prices because they are very volatile and mostly transitory and as a result don’t necessarily reflect underlying inflation trends. A central objective of the Fed’s monetary policy is price stability, defined as a low, steady rate of overall inflation. So are rising food and gas prices a sign that the Fed is falling down on the job?
The answer is no. There is very little that the Fed can do to control today’s inflation, whether core or headline. What the Fed does influence is inflation a year or two down the road, which is why it needs to look to the future, not overreact to the present.
The most significant question for the Fed, then, is whether overall or core inflation right now is a more reliable gauge of where headline inflation will be next year. And the data unequivocally tell us that core inflation better predicts overall inflation tomorrow.
But talk is cheap when it comes to inflation. Far more persuasive are the numbers, and on that score there's still plenty of support for taking core seriously. As Marcus Nunes recently reminded, reviewing the long sweep of history between core and headline inflation should give us pause before throwing out the former in favor of the latter. Consider that during the inflationary surge of the 1970s, core inflation and headline inflation indices were rising in tandem. This was a true inflationary episode. As Nunes notes, "What stands out is the fact that during the 'Great Inflation' of the 1970s, the ‘sticky components’ became unstuck! That´s what we mean by inflation: a continuing rise in all prices." This is quite clear in the chart below, which compares the unadjusted annual rates of headline consumer price inflation (blue line) with its core reading (red line) from 1960 to the present.
This time there’s more of a divergence between headline and core. In recent years, headline inflation has popped up when energy and/or food prices spiked. But as the trend in core inflation suggests, these pops were temporary and not necessarily indicative of an inflation problem per se, at least not to a degree on par with the 1970s. Nonetheless, if you think that headline inflation is a better measure of pricing pressures, there’s a strong case for raising interest rates now, a point that Bullard seems to be emphasizing.
On the other hand, the argument for being cautious on tightening if only headline inflation is bound up with the expectation that inflation will remain contained until (or if) core inflation starts to rise as well. For the moment, however, there’s still some debate if the latter condition applies. Indeed, the economy is still weak on a number of fronts, starting with the high jobless rate, and so the outlook for inflation is questionable.
Ultimately, the numbers will have the last word. Although the relatively low core readings provide a level of comfort that inflation isn’t poised to take off, there’s always the possibility that it could be different this time. To be fair, core readings are only one metric, and Bullard’s certainly right that we should be skeptical of any one data point. That’s still no excuse to ignore core. There was nothing in Bullard's speech that provides a smoking gun for abandoning a narrow view of inflation for short-term monetary policy adjustments.
Meanwhile, when we look to other measures of inflation risk, there’s additional evidence that prices aren't like to surge in the foreseeable future. The Treasury market’s inflation forecast, for instance, is now falling again. As of yesterday, the implied inflation forecast based on the yield spread between the nominal and inflation-indexed 10-year Treasuries was 2.32%, down about 30 basis points from a month ago and roughly equal to the market's prediction in February. The market can be wrong, of course, but you need a good reason to question the crowd's collective pricing.
It all boils down to whether you believe that food and energy prices will continue rising for years to come without a sustained downturn. That may be fate, and it’s a possibility that no one should dismiss lightly. But it’s a prediction. History suggests we should be cautious in extrapolating recent price trends as a fact for the long run future. If we haven’t learned that lesson at this late date, there’s not much hope for thinking clearly.
The next few months may prove decisive on deciding if core is misleading us. But for the moment, the jury’s out. Core inflation is hardly a silver bullet, but it’s debatable if it’s rotten.
May 23, 2011
Tactical ETF Review: 5.23.2011
The economy may be facing new headwinds, but the depth of the threat is still an open debate for those who worship at the altar of momentum and technical analysis. Representative ETFs for the major asset classes are no longer making new highs, but the selling so far has been modest. That's no assurance that all's well, of course, although the fact that prices have held up relatively well in the face of fresh macro worries is impressive. In fact, the latest round of anxiety has inspired the U.S. bond market to rally sharply, albeit for all the wrong reasons. Indeed, caution is in the air elsewhere. The week ahead may be a potent test for the crowd's resiliency as updates arrive in the days to come for durable goods orders, initial jobless claims, and personal income and spending. Meantime, here's a closer look at how the major asset classes stack up via proxy ETFs as of Friday's close:
US STOCKS • Vanguard Total Market (VTI) • Benchmark: MSCI US Broad Market Index
Steady as she goes. U.S. equities are holding just above a support line...
FOREIGN DEVELOPED MARKET STOCKS • Vanguard Europe Pacific (VEA) • Benchmark: MSCI EAFE
Stocks in foreign developed markets are also taking a wait-and-see approach...
EMERGING MARKET STOCKS • Vanguard Emerging Markets (VWO) • Benchmark: MSCI Emerging Market
The sellers are more aggressive in emerging market stocks...
US BONDS • Vanguard Total Bond Market (BND) • Benchmark: Barclays US Aggregate
U.S. bonds have revived sharply over the past month on new concerns about the economy...
INFLATION-INDEXED US TREASURIES • iShares Barclays TIPS Bond (TIP) • Benchmark: Barclays US TIPS
The rally in inflation-indexed Treasuries, however, seems to have run out of gas...
HIGH YIELD BONDS • SPDR Barclays High Yield Bond (JNK) • Benchmark: Barclays High Yield Very Liquid
Technical strength in junk bonds continues to roll on...
COMMODITIES • iPath Dow Jones-UBS Commodity (DJP) • Benchmark: DJ-UBS Commodity
Commodities have taken a hit amid worries of a new rough patch for the economy...
REAL ESTATE INVESTMENT TRUSTS • Vanguard REIT (VNQ) • Benchmark: MSCI US REIT
The roaring bull market for REITs is taking a breather, but just barely...
FOREIGN DEVLOPED MARKET GOVERNMENT BONDS • SPDR Barclays Int’l Treasury (BWX) •
Benchmark: Barclays Global Treasury ex-US Capped
In contrast with US bonds, foreign fixed income is on the defensive, due in no small part to the revival in the dollar's fortunes in forex markets in recent weeks...
EMERGING MARKET GOVERNMENT BONDS • Van Eck Market Vectors Emg Mkt Local Currency Bond (EMLC) •
Benchmark: J.P. Morgan GBI-EMG Core
Buyers of emerging market bonds, on the other hand, aren't so quick to give in to the bears...
FOREIGN GOVERNMENT INFLATION-LINKED BONDS • SPDR DB International Inflation-Protected Bond (WIP) •
Benchmark: DB Global Government ex-US Inflation-Linked Bond Capped
Buyers of foreign inflation-indexed bonds have fought the sellers back to a standoff in recent days...
FOREIGN CORPORATE BONDS • PowerShares International Corporate Bond (PICB) •
Benchmark: S&P International Corporate Bond
And the market in foreign corporate bonds is also, for the moment, sitting on a fence between the bulls and bears...
Charts courtesy of StockCharts.com
May 21, 2011
Book Bits For Saturday: 5.21.2011
● Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon
By Gretchen Morgenson and Joshua Rosner
Summary via publisher, Times Books
In Reckless Endangerment, Gretchen Morgenson, the star business columnist of The New York Times, exposes how the watchdogs who were supposed to protect the country from financial harm were actually complicit in the actions that finally blew up the American economy. Drawing on previously untapped sources and building on original research from coauthor Joshua Rosner—who himself raised early warnings with the public and investors, and kept detailed records—Morgenson connects the dots that led to this fiasco. Morgenson and Rosner draw back the curtain on Fannie Mae, the mortgage-finance giant that grew, with the support of the Clinton administration, through the 1990s, becoming a major opponent of government oversight even as it was benefiting from public subsidies. They expose the role played not only by Fannie Mae executives but also by enablers at Countrywide Financial, Goldman Sachs, the Federal Reserve, HUD, Congress, the FDIC, and the biggest players on Wall Street, to show how greed, aggression, and fear led countless officials to ignore warning signs of an imminent disaster.
● What Would Ben Graham Do Now?: A New Value Investing Playbook for a Global Age
By Jeffrey Towson
Excerpt via publisher, FT Press
With Graham’s value approach as their weapon, generations of investors have laid siege to confusing and seemingly chaotic markets. And slowly and grudgingly, previously inscrutable markets and systems have become both understandable and actionable. Graham’s approach has proved to not only be exceedingly profitable but also fascinating. The opportunity to understand the business world as it really exists, outside of our limited perceptions, is as satisfying as the returns. Graham’s thinking offers what physicist and Nobel Laureate Richard Feynman called “the pleasure of finding things out.” Unsurprisingly, value investing tends to attract both the ambitious and Feynman-type “curious characters.”
This book started with a similar emotional reaction. Almost a gut feeling—that at the start of the first global century, confusion and anxiety seem to be growing. I am increasingly struck by the sense of gloom and doom Westerners in particular have about globalization and a changing world. The U.S. is in decline? Globalization will move my job overseas? The global financial system is precariously unstable and will inevitably collapse? The future is one of belt tightening and lowered ambitions? China’s rise fundamentally threatens the West? (How many ways can the word dragon be used in a book title?)
● Death by China: Confronting the Dragon - A Global Call to Action
By Peter W. Navarro and Greg Autry
Summary via publisher, FT Press
China is now the #1 danger facing America. Best-selling author and economist Peter Navarro and coauthor Greg Autry expose every form of "death by China"–from lethal products to espionage, imperialism, and nuclear proliferation, through China's relentless attack on the U.S. economy. A must-read book for every American, by the best-selling author of The Coming China Wars.
● The Contemporary Global Economy: A History since 1980
By Alfred E. Eckes Jr.
Summary via publisher, Wiley-Blackwell
The Contemporary Global Economy provides a lively overview of recent turbulence in the world economy, focusing on the dynamics of globalization since the 1980s. It explains the main drivers of economic change and how we are able to discern their effects in the world today.
● Business as Usual: The Economic Crisis and the Failure of Capitalism
By Paul Mattick
Summary via publisher, Reaktion Books
In Business as Usual Paul Mattick explains the recession in jargon-free style, without shying away from serious analysis. He explores current events in relation to the development of the world economy since the Second World War and, more fundamentally, looks at the cycle of crisis and recovery that has characterized capitalism since the early nineteenth century. Mattick situates today’s crisis in the context of a capitalism ruled by a voracious quest for profit. He places the downturn within the context of business cycles and uses this explanation as a springboard for exploring the nature of our capitalist society, and its prospects for the future.
May 20, 2011
Is The Treasury Market's Inflation Forecast Flashing A Warning?
The outlook for inflation is dropping fast, according to the yield spread between the nominal and inflation-indexed 10-year Treasuries. That's worrisome if the economy's growth momentum is slowing. Although some pundits argue that higher inflation is a big risk, the Treasury market is telling us different. If the economy is downshifting, falling inflation expectations are a sign of trouble.
The latest inflation forecast is 2.26%, based on yesterday’s yield spread for 10-year Treasuries. That represents a modest but consistent drop from just a month earlier, when the forecast was 2.6%. The decline is still moderate in absolute terms, which raises the possibility that it's all just noise. But with some analysts warning that the economy may be headed for a rough patch, lower inflation expectations at this juncture aren't productive.
"There's a downturn in global industrial growth in clear sight," predicts Lakshman Achuthan, managing director of the Economic Cycle Research Institute (ECRI). Given ECRI's impressive record for calling major turning points in the business cycle, Achuthan's warning isn't easily dismissed.
Looking on the bright side, the latest broad profile of the U.S. economy still suggests growth has the upper hand. The Chicago Fed National Activity Index (a a weighted average of 85 Indicators) rose in March. That was “the fourth consecutive positive reading of the index and the sixth consecutive positive contribution from employment-related indicators. Neither has exhibited such patterns since April 2006,” the Chicago Fed reports.
But March is suddenly ancient history. More recent economic news is mixed. For example, the pace of growth for the ISM Manufacturing Index for April slowed, as did the ISM services industry index. Then again, April's private nonfarm payrolls increased by the most since the recession ended, although the recent rise in new jobless claims has raised new questions about the labor market's resiliency.
Meantime, an early reading on economic activity for this month paints a cautious picture. Business activity in the Philadelphia region continued to rise in May, but the gain was the weakest in eight months, the Philadelphia Fed reports.
ECRI's prediction notwithstanding, it's too early to throw in the towel on growth. Indeed, last month's rise in payrolls suggests there's still a fair amount of forward momentum in the economy. Still, it would be foolish to ignore the warning signs. Much depends on the trend implied in the incoming round of economic reports. Next week, for instance, brings fresh numbers on durable goods orders, initial jobless claims, and personal income and spending.
Meantime, let's keep an eye on the Treasury market's inflation forecast. If this prediction continues to drop, it's sure to cast a dark shadow over the macro view. Ironically (or tragically), a similar warning started bubbling about this time last year, as we noted at the time (here and here, for instance). The falling inflation forecast was an early sign of trouble in the spring of 2010. It's premature to argue that a repeat performance is fate, but it's also too early to dismiss the possibility.
May 19, 2011
Do High Gasoline Prices Threaten Consumer Spending?
The rebound in retail sales is at the top of the list for thinking that the economy will weather any challenges to growth in the months ahead. Consumer spending, after all, accounts for roughly 70% of GDP, as we’ve so often been told. That implies that a robust rate of growth in retail sales is just what the doctor ordered to chase away the business cycle blues. The good news is that the headline number for retail sales certainly looks encouraging these days. But if we strip out sales at gasoline stations, the case for optimism suffers a bit.
The first chart confirms that retail sales have rebounded sharply since the Great Recession. In fact, total nominal sales have recently hit new highs on a seasonally adjusted basis (black line). Joe Sixpack is spending more than ever. But if we strip out retail gasoline station sales (red line), the trend isn't quite so strong. Every dollar spent on gasoline is presumably a dollar less spent elsewhere on goods and services that are more likely to contribute to economic growth.
The question is whether there’s anything surprising in the retail sales numbers after adjusting for gasoline consumption? Not necessarily. As the economy grows, so too does spending on gasoline. A decline in gas consumption usually means that the economy’s in trouble. It’s no wonder that gasoline sales tumbled in the Great Recession and then rebounded once the recovery arrived. But with gas prices surging recently, one might wonder how deeply energy costs are pinching consumers.
The next chart provides a clue by way of monitoring gasoline sales as a percentage of total retail sales. As you can see, this measure is nearing the old high reached back in August 2008, when gasoline sales comprised more than 12% of retail sales. As of last month, the comparable figure was 11.8%.
The share of retail sales that go to gasoline is to some extent a function of price. Only if gasoline prices continue to rise should we expect that a bigger slice of retail sales will be diverted to paying more at the pump. Given the volatile history of commodities, however, one might expect that soaring gasoline prices over the last year will abate soon and perhaps even reverse course.
The key issue is assessing the impact on the broad trend in retail sales. For the moment, gasoline is taking a toll that’s more than negligible. As the third chart shows, the rolling 12-month percentage change in retail sales ex-gasoline (gold line) is considerably lower vs. the headline counterpart (green line). If the retail ex-gasoline trend continues to suffer in a material way vs. total sales, that may be a warning sign of some significance.
Indeed, in 2008, the trend in retail ex-gasoline deteriorated rapidly, providing a clue that the high energy costs were biting deeply into consumer spending habits. Headline retail sales held up much better, at least for a time, although this was a misleading bit of optimism. As we now know, the recession had already begun, in December 2007, although there was some debate in real time about the economy's health, even as late as the summer of 2008. The trend in retail sales ex-gasoline, however, was sending a clear message of reality earlier than retail sales overall.
For the moment, the trend in retail ex-gas still looks healthy. But all bets are off if this measure deteriorates further in absolute and relative terms. The price of gasoline is to some extent destiny here. If prices fall sharply, or at least remain steady, the worst may be over. But Joe Sixpack’s state of mind is crucial too, and it’s unclear how much of a drop in gas prices is required to perk up his spirits (and his spending).
Jobless Claims Fall For 2nd Week
You can almost hear the collective sigh of relief after reading this morning’s update on initial jobless claims. There really wasn’t much room for more bad news, which makes last week sizable fall in new filings for unemployment benefits all the sweeter. Yup, we dodged a bullet here--for the second week in a row. Jobless claims are still running too high to offer much comfort, but there’s a stronger argument today in favor of seeing the recent jump in this series as a statistical blip…maybe. One week at a time here... again.
In any case, new claims tumbled by 29,000 last week to a seasonally adjusted total of 409,000. The drop follows the previous week’s revised 40,000 decline. That brings us back into the range of claims that prevailed before new filings suddenly surged in April and sent shivers down the spines of optimists everywhere. Claims are still running at recession-level numbers and so there’s no room for celebration. But if the weeks ahead bring more signs of progress--just holding steady would be progress at this point--we may be close to writing the recent past off as just one of those things.
Some economists are already leaning toward that interpretation. "There has been a lot of volatility in recent weeks and it looks like the prior week’s number was bolstered by all the damage from the tornadoes in Alabama and also to some of the layoffs due to parts shortages at the auto manufacturers," advises Mark Vitner, senior economist at Wells Fargo via Reuters. "When you take into account those temporary glitches the trend in jobless claims looks a little bit better, although 409,000 weekly jobless claims is still pretty high."
Deciding when new claims are poised for a sustained tumble is anyone’s guess. Until materially lower numbers arrive, however, the labor market’s likely to continue growing at a modest rate. In other words, we’re still digging ourselves out of the same hole we had before the April surge. At least the hole isn’t any deeper, although it was plenty deep enough to begin with.
“Unemployment remains stubbornly high, hampering overall consumer sentiment and spending,” Gregg Steinhafel, chairman and chief executive officer of the retail chain Target, complains via a conference call yesterday according to Bloomberg. “While the U.S. economy is showing some signs of improvement, we expect the recovery will continue to be slow and uneven."
For the time being, there's not many willing to offer a dramatically brighter forecast.
May 18, 2011
Barry Eichengreen on the risk from changes in global economic power and influence:
Shifts in global economic and financial power create unfamiliar circumstances, and unfamiliar circumstances create risks. In the 1960s and 1970s the rising powers, Europe and Japan, complained of destabilizing economic impulses emanating from the United States. This source of economic risks has been around for a long time, in other words, although its form continues to mutate. But now, in addition, the U.S. and other advanced economies must worry about the risk of adverse shocks arising out of events in China and other emerging markets. The day when the Chinese economy was too small and isolated to have a first-order impact on the rest of the world is long past, in other words. Policy analysts in the U.S. and other advanced countries need to worry about the impact on their own economy of a sharp economic slowdown in China, of a sudden drop in property prices in that country’s major cities, or of an outbreak of labor unrest. These are not matters on which U.S. policy planning has traditionally focused. It now should.
Workers Of The World Unite... And Spend
Dominique Strauss-Kahn has some explaining to do that goes beyond defending himself against sexual assault charges. Maybe it's just me, but I'm having a hard time squaring DSK's preference (and financial ability) for living large and his political alliance with socialism. It's been a long road from the Paris Commune to Porsche, the 21st century symbol of socialism.
The Big Fade On The REIT Yield Premium
It’s been more than two years since the markets hit bottom after the financial crisis of late 2008/early 2009. What a long strange trip it’s been. It may get stranger still. But in the interest of finding some context, it’s useful to compare returns since the trough. Let’s arbitrarily call the end of February 2009 as the bottom. How have markets fared since?
The chart below compares several of the usual suspects, including my proprietary benchmark of all the major asset classes: the Global Market Index. The clear leader: REITs. The MSCI REIT Index, quite simply, has soared. Even emerging market stocks haven’t kept pace.
But the burden of leadership eventually takes a toll. Mean reversion, in other words, is usually lurking. The thought comes to mind in reviewing the strength of REITs. In absolute and relative terms, performance has been on a tear. But when we look at REIT yields, it’s easy to turn cautious. Relative to a 10-year Treasury, the traditional yield premium in REITs has evaporated lately. That’s a sign that the asset class may be headed for rough waters.
The last time REIT yields slipped below the prevailing rate on the 10-year Note during the spring of 2010, a wave of selling descended. For instance, the Vanguard REIT ETF (VNQ) was trading well above $52 a share in late April 2010. At the time, there was little or no yield premium for REITs, according to data from NAREIT. By early July, the ETF had shed nearly 20%.
Previous episodes of negative REIT yield premiums over the years have also brought lower prices. The good news is that lower prices do wonders for raising yield premiums and expected return. For example, buying REITs in late August 2010, when the yield premium had risen to a percentage point from the spring's premium of nada, delivered tidy gains in the months ahead. Indeed, the Vanguard REIT ETF is up by a handsome 20% these days from last August.
Is the yield premium for REITs destiny? Not necessarily, but valuation can’t be denied indefinitely. It seems as though it's a good time to rebalance your REIT allocation if it's bursting at the seams. If not now, when?
May 17, 2011
Housing Activity Weakens In April & Industrial Production Is Flat
Today’s update on new housing starts and building permits for April isn’t surprising, but it’s still not encouraging. Permits slipped 4% last month and are down by nearly 13% from a year ago. Housing starts look even worse, falling nearly 11% in April, pushing the seasonally adjusted annual rate down by 24% vs. the year-earlier number.
The residential real estate market remains in a deep slump and there’s nothing in today’s numbers from the Census Bureau to tell us different. The only questions: 1) Will the slump worsen; and 2) if the answer to first question is yes, will it drag down the rest of the economy?
Answering no in both cases is still reasonable, although the level of confidence with that outlook is far from robust. The main bit of evidence for thinking that we’re not looking at a new leg down comes from reviewing history. As the chart below reminds, starts and permits have been moving sideways for three years. Unless you think a new recession is lurking, there's a case for predicting that the range will hold. Today’s update brings us into the lower realm of that range, but there’s nothing unusual here, judging by recent history.
Then again, if the broader economy is set for another rough patch, the housing market may suffer even deeper levels of pain. Unfortunately, the margin for comfort is now unusually thin. Last year at this time, starts and permits were moderately higher. That didn’t stop the summer slump of 2010 from taking a toll. But the worst levels in starts and permits of last year are now north of current numbers.
It doesn’t help to learn that industrial production was flat last month vs. March, or that manufacturing production slipped 0.4% in April after nine straight months of growth, according to the Federal Reserve update today.
The good news is that the broad trend for industrial production is still positive, as the second chart below shows. Indeed, the 5% year-over-year increase for this series last month is well above average. Historically, that's a strong number. Of course, it’s destined to fade as the cycle ages, and perhaps by more than the crowd expected just a few weeks ago.
Analysts say that industrial production stalled last month because of a drop in auto production, which was hit by the blowback from supply-chain disruptions due to the Japanese earthquake in March. In other words, technical difficulties are to blame. Maybe so, but that doesn’t change the fact that housing is still weak and possibly set to get weaker. Meantime, new questions about the labor market’s strength are still bubbling.
The focus now shifts to Thursday’s update on new jobless claims. The consensus forecast calls for a modest drop. A negative surprise of any magnitude, however, may bring a major attitude adjustment on the general outlook.
Slim Index Pickings In 401(k) Plans
Ron Lieber argues that 401(k) plans should offer index funds. "This shouldn’t be a controversial statement," he writes in a recent New York Times article. "Yet it passes for one in Washington, where regulators and legislators are still mired in a never-ending debate over whether stockbrokers, certain insurance salespeople and others ought to meet that standard, known in legal circles as a fiduciary duty."
The case for using index funds is compelling at this late date. The battle to bring these products front and center to 401(k) retirement plans, however, isn't new. Two years ago, The Wall Street Journal reported on a new push to expand index fund options for 401(k) investors. But as Lieber's story suggests, there's been modest progress at best.
Even when 401(k) plans offer index funds, there's less than meets the eye. Lieber notes that while 82% of all U.S. plans provide a stock index fund, a mere 37% offer a trio of domestic equity, foreign equity and bond index funds. This is a serious obstacle if you're trying to design and manage an intelligent asset allocation strategy. As we discuss regularly on these pages, a conservative reading of the major asset classes turns up at least a dozen choices. Even if you're one of the lucky few with the three index fund choices noted above in your 401(k), your options are severely limited relative to what's otherwise available to the general public in ETFs and index mutual funds.
It's clear that a basic risk-management system requires a modest degree of portfolio rebalancing. But your odds for success with rebalancing are much lower if the asset class options are constrained. Yes, you can use the wider menu of actively managed funds in 401(k) plans as a supplement, but this opens investors to all the usual caveats, including higher fees, fuzzy investment mandates, and a higher risk of earning subpar results.
It's nothing less than astonishing that the basic investment options that provide investors with a decent chance of success over the long term are still the exception in the primary retirement account in these United States. It's a mystery why financial regulators don't require all 401(k) plans to offer an informed list of index fund options. Then again, maybe it's not so mysterious. It's Washington, after all.
This isn't rocket science, although it is critical that investors are allowed to choose from a broad palette of low-cost betas to build portfolios. But even this fundamental building block of money management is out of reach for most 401(k) investors.
May 16, 2011
Slower Growth vs. Slow Growth
Manufacturing activity in the state of New York “improved in May, but at a slower pace than in April,” according to this morning’s update of the Empire State Manufacturing Survey from the New York Fed. Meanwhile, the outlook for U.S. economic growth softened a bit according to economists surveyed by the National Association for Business Economics. "NABE panelists revised their projections for economic growth in 2011 downward compared with their February projections," says Richard Wobbekind, NABE president in a statement. "Real GDP is expected to grow at a moderate pace of roughly 3 percent in the current year and only slightly faster in 2012."
The risk of a slowing rate of growth for the economy isn’t particularly shocking, given the recent jump in jobless claims. As for rounding up suspects, NABE’s Wobbekind notes:
The main factors restraining growth include high and rising commodity prices, uncertainty about future federal government economic policies, a tepid housing market, and financial headwinds. Panelists remain highly concerned about federal deficits and debt, and are increasingly concerned about rising commodity prices and inflation.
It’s still unclear if this slowdown is merely a statistical blip or something deeper. Fresh clues arrive with tomorrow’s update on housing starts and industrial production. But the week’s big number arrives on Thursday, with the update of weekly jobless claims. The consensus forecast calls for a slight decline to a seasonally adjusted 420,000, according to Briefing.com. That’s still elevated, but any drop would be welcome at what’s shaping up to be another critical juncture in the spring.
For the moment, at least, forecasters are more cautious but they’re still not predicting outright trouble. A report released on Friday from the Philadelphia Fed, for instance, advised:
Growth in the U.S. economy looks a little slower now than it did three months ago, according to 44 forecasters surveyed by the Federal Reserve Bank of Philadelphia. Our panelists expect real GDP to grow at an annual rate of 3.2 percent this quarter, down from the previous estimate of 3.5 percent. On an annual-average over annual-average basis, the forecasters also predict slower real GDP growth over the next four years. The forecasters see real GDP growing 2.7 percent in 2011, down from their prediction of 3.2 percent in the last survey. The forecasters predict real GDP will grow 3.0 percent in 2012, 2.8 percent in 2013, and 3.3 percent in 2014, each somewhat lower than their respective predictions in the last survey.
The Philly Fed survey also noted that the “outlook for the labor market is mixed.” Exactly how mixed is now the focus… again. April’s growth in payrolls is suddenly ancient history.
Strategic Briefing | 5.16.2011 | US Debt Ceiling
Debt ceiling drama starts today
CNNMoney | May 16
Monday's the day: The federal debt will hit its legal limit and Congress doesn't plan to do anything about it. That leaves Treasury Secretary Timothy Geithner in a bit of a pickle. It now falls to him to jump through hoops every day to keep the world's largest economy from defaulting on its legal obligations. Geithner told Congress that he estimates he has enough legal hoop-jumping tricks to cover them for another 11 weeks or so. But then he said that's it. If lawmakers don't get it together by Aug. 2, the United States will no longer be able to pay its bills in full.
A sword of Damocles for the debt ceiling
Sen. Pete Domenici and Alice Rivlin (Washington Post) | May 15
Congress must increase the debt limit in the next few weeks to avoid a financial crisis. Calls for default on the obligations our government has already incurred are reckless posturing that does nothing to alter future obligations and makes the world doubt our elected representatives’ ability to govern responsibly. We favor raising the debt ceiling promptly and mandating actions to put the federal budget back on a sustainable path.
Boehner says the debt ceiling must increase
The Hill | May 15
Speaker John Boehner (R-Ohio) said he’s “ready to cut a deal today” to raise the debt ceiling. “I think it is necessary, but I understand the doubts,” Boehner said on “Face the Nation.” “They’ve pushed the date back, pushed the date back, pushed the date back. But it’s clear to me that at some point we’re going to have to raise the debt ceiling.” Senate Minority Leader Mitch McConnell (R-Ky.) said he wouldn’t vote to increase the debt limit unless deficit reductions are made. Boehner has made similar demands.
America Held Hostage
Paul Krugman (NY Times) | May 15
Now, there are good reasons to believe that the G.O.P. isn’t nearly as willing to burn the house down as it claims. Business interests have made it clear that they’re horrified at the prospect of hitting the debt ceiling. Even the virulently anti-Obama U.S. Chamber of Commerce has urged Congress to raise the ceiling “as expeditiously as possible.” And a confrontation over spending would only highlight the fact that Republicans won big last year largely by promising to protect Medicare, then promptly voted to dismantle the program. But the president can’t call the extortionists’ bluff unless he’s willing to confront them, and accept the associated risks. According to Harry Reid, the Senate majority leader, Mr. Obama has told Democrats not to draw any “line in the sand” in debt negotiations. Well, count me among those who find this strategy completely baffling. At some point — and sooner rather than later — the president has to draw a line. Otherwise, he might as well move out of the White House, and hand the keys over to the Tea Party.
US should sell assets like gold to get out of debt, conservative economists say
Washington Post | May 15
With the United States poised to slam into its debt limit Monday, conservative economists are eyeballing all that gold in Fort Knox. There’s about 147 million ounces of gold parked in the legendary vault. Gold is selling at nearly $1,500 an ounce. That’s many billions of dollars in bullion. “It’s just sort of sitting there,” said Ron Utt, a senior fellow at the Heritage Foundation. “Given the high price it is now, and the tremendous debt problem we now have, by all means, sell at the peak.” But that’s cockamamie, declares the Obama administration. Mary J. Miller, Treasury’s assistant secretary for financial markets, said the U.S. should sell assets in an orderly, “well-telegraphed” manner, not in a “fire sale” atmosphere with a debt limit deadline accelerating the process.
Testimony of Prof. Matthew Slaughter, Dartmouth
US House of Representative | May 11
Some might ask, couldn’t a deficit-reduction plan be crafted and implemented that would create fiscal balance and thus prevent America from breaching its looming debt ceiling? Speaking practically, the answer is no. As of May 3 the total amount of federal debt outstanding was about $14.28 trillion. The debt limit is $14.294 trillion. Even if America wanted to do so, there simply is not enough calendar time for America to rewrite its spending and taxing laws to prevent reaching this limit. Speaking economically, the answer should also be no. There is no doubt that America must soon control its massive fiscal deficits. But doing so immediately would require such a massive combination of spending cuts and/or tax increases that it would almost surely throw America back into a deep recession. This real economic hardship on American workers and families would not be worth enduring for the sake of immediate fiscal balance.
The Outcome of the Debt Ceiling Battle Could Hurt the Economy
Mark Thoma (Economist's View) | May 15
If politicians fail to reach a deal to increase the debt ceiling, there would be a large fall in federal spending. The decline in federal purchases of private sector goods and services would reduce aggregate demand, and this could slow or even reverse the recovery (it could also threaten the delivery of critical services that some people depend upon). In addition, the failure to pay wages to federal workers would disrupt household finances and cause a further decline in demand, as would the failure of the government to pay its bills for the goods and services it has already purchased from the private sector (and it could even threaten some households and businesses with bankruptcy should the problem persist). There may be some room for the Treasury to use accounting tricks to avoid the worst problems, at least for a time, but it is not at all clear how well this would work to insulate the economy from problems and eventually this strategy will come to an end.
The Debt Ceiling: What is at Stake?
Mercatus Center at George Mason University | Apr 28
Congress is currently considering whether it should raise the debt ceiling. This is not new territory. Congress has raised the debt ceiling ten times in the last ten years.3 However, raising the debt ceiling for the eleventh time in as many years without recognizing and correcting systemic problems would have consequences beyond merely tapping revenue and assets to meet FY2011 budget commitments. Continuing to pass debt ceiling increases without proper spending reforms would be irresponsible. The United States should not consider defaulting on its debt, nor should it put itself in a position where it has to postpone payment to contractors or “manage” other non-debt obligations. Neither, however, should Congress be forced to raise the debt ceiling under false pretenses. By our calculations, the United States has enough expected cash flow (tax revenue) and assets on hand to avoid either of these unattractive options until at least the end of the current fiscal year in September, perhaps even longer.
No Deal in Sight as Debt Deadline Nears
Frum Forum | May 15
Bond ratings, basically, assess the chances of default and, if a politically caused default is likely, credit will freeze up. Because other countries don’t have debt ceilings–or, for that matter, legislatures that are co-equal branches of government—there’s no exact precedent for a downgrade happening in these circumstances but the logic of bond rating suggests that one would take place and a recession would follow. And Republicans—a few of whom on the party’s fringes seem to relish in the idea of forcing a default—need to be careful of what they wish for: even a debt downgrade would hurt the party terribly.
May 14, 2011
Book Bits For Saturday: 5.14.2011
● The Next Convergence: The Future of Economic Growth in a Multispeed World
By Michael Spence
Review in The Economist
Never before have so many people grown rich so quickly. Japan was the first country to achieve sustained, high-speed growth, in the post-war years, but it did so alone. A handful of smallish Asian tigers followed. Mr Spence wonders whether that formula can work when 60% of humanity, led by India and China, try the same thing. Globalisation, he notes, has been critical to the rapid growth of emerging markets. But it has also led to rising inequality in the rich countries, and they may now well respond by raising protectionist barriers. Or maybe not. Mr Spence is not sure about this nor, unfortunately, of many of the other issues he tackles. “The Next Convergence” feels less like a book than a transcript of the author thinking out loud about a hotch-potch of contemporary economic issues.
● Adapt: Why Success Always Starts with Failure
By Tim Harford
Interview with author via The New York Times
Tim Harford is a columnist for The Financial Times and the author of The Undercover Economist. He’s part of the growing cadre of journalists who try to write about economics in plain English. His new book, Adapt: Why Success Always Starts With Failure, will be published this week. Our conversation follows...
Harford: One of the main ideas of the book is that the world is full of interesting ideas that might help solve some of our big problems, but nobody really knows which of these ideas will work and which will fail. So policy makers, corporate leaders and social campaigners need to be much more open to all sorts of formal and informal experiments. Jamie Oliver created an accidental experiment. It would be nice if we spent a bit more energy doing this deliberately.
● The First Great Recession of the 21st Century: Competing Explanations
Edited by Óscar Dejuán, Cristina Marcuzzo and Eladio Febrero
Summary via publisher, Edward Elgar
The 2008–10 financial crisis and the global recession it created is a complex phenomenon that warrants detailed examination. The essays in this book utilise several alternative paradigms to provide a plausible explanation and a credible cure. This book provides this important analysis in great detail and from different theoretical perspectives, presenting a clearer understanding of what went wrong and expounding misinterpretations of current theories and practices.
● Global Financial Crisis: The Ethical Issues
Edited by Ned Dobos, Christian Barry and Thomas Pogge
Summary via publisher, Palgrave Macmilan
The Global Financial Crisis is acknowledged to be the most severe economic downturn since the 1930s, and one that is unique in its underlying causes, its scope, and its wider social, political and economic implications. This volume explores some of the ethical issues that it has raised.
● The New International Money Game (7th ed.)
By Robert Z. Aliber
Summary via publisher, Palgrave Macmillan
When Robert Z. Aliber's The International Money Game first appeared in 1973, it was widely acclaimed as the best – and the most entertaining – introduction to the arcane mysteries of international finance. The 7th edition of this classic work has been fully re-written to recognize the immense changes in the global economy in the last thirty five years. There have been four waves of financial crises; each wave has involved the failures of banks and other financial institutions in three, four, or more countries. Each wave of crises has been preceded by a wave of credit bubbles, which has involved the increase in the indebtedness of a group of borrowers at rates in the range of twenty to thirty percent a year for three or four or more years. These bubbles are related to global imbalances. A substantive preface surveys these major changes since the first edition. As in previous editions, Aliber's aim is not just to be topical. His witty, perceptive, and authoritative book focuses on fundamentals, on 'how the pieces fit'. Aliber provides an indispensable and highly readable guide to the complex and increasingly fragile arrangement for financing the world's business.
● Housing Markets and the Global Financial Crisis: The Uneven Impact on Households
Edited by Ray Forrest and Ngai-Ming Yip
Summary via publisher, Edward Elgar
Housing markets are at the centre of the recent global financial turmoil. In this well-researched study, a multidisciplinary group of leading analysts explores the impact of the crisis within, and between, countries. The impacts of the so-called global crisis are, in fact, highly uneven for both households and institutions. This unique book investigates why this is the case as well as emphasizing the consequences. It encompasses the experiences of all the major economies, including: Australia, China, Hong Kong, Hungary, Iceland, Ireland, Japan, New Zealand, South Korea, the UK, the USA and Vietnam, highlighting and comparing a wide range of housing systems and crisis impacts.
May 13, 2011
Looking For Demons In Consumer Price Inflation
Headline consumer price inflation (CPI) rose 0.4% last month on a seasonally adjusted basis, or slightly lower than March’s 0.5% increase, the Labor Department reports. That translates into a 3.1% rise over the past year. Inflationary pressures, at least by the government’s reckoning, remain modest. Ditto for the outlook on economic growth, which suggests that inflation isn't likely to be a major problem for the foreseeable future. The usual suspects will nonetheless scream otherwise, but it’s hard to make that case based on the Labor Department's numbers.
Arguing that inflation isn't an imminent threat looks even more persausive when we review core CPI data. Yes, the annual pace of core CPI inched higher last month to 1.3%, the highest rate since February 2010. But that’s still middling to low relative to the past decade. If core CPI rising by 1.3% is somehow viewed as dangerous, why were there so few cries of alarm in September 2006, when core CPI was advancing on the year at a much higher level: nearly 3% at the time?
Some critics will argue anew that core CPI is misleading because it strips out food and energy prices. No matter that the economic logic for doing so is compelling to avoid getting whipsawed with price signals via volatile commodity prices. Indeed, as the chart above reminds, headline inflation was soaring in mid-2008 while core inflation remained modest. Which measure was the better indicator? The chart above offers an unambiguous answer.
A number of skeptics simply reject the government’s statistics outright, arguing that inflation is much, much higher. For instance, by one accounting consumer price inflation is advancing by 10% a year if we use an older methodology for calculating CPI. That view stokes the fires of populist politics and sounds reasonable to the casual observer on Main Street, but as Ramesh Ponnuru points out: If CPI is increasing by 10% a year, the the annual, real (i.e., inflation-adjusted) growth rate for the U.S. economy in this year’s first quarter would be deeply negative by 7%-8% vs. the 1.8% real positive growth reported by the Bureau of Labor Statistics.
In other words, if you think inflation is really soaring by 10%, that implies that the U.S. economy is virtually imploding on a real basis. A reality check via various statistics suggests otherwise. Sure, the recovery is weak to modest these days, but no reasonable analysis of the trend for the broad economy of late suggests that we're suffering something comparable to the economic tsunami that hit in late-2008/early 2009.
May 12, 2011
Jobless Claims Remain Elevated Despite Last Week's Sharp Decline
Initial jobless claims dropped sharply last week, the Labor Department reports, but we’re still not out of the woods. The recent jump in new filings for jobless benefits went into reverse, but no one can ignore the still-elevated levels for this series. And until we see more reports like this morning's, there's going to be some awkward questions.
Seasonally adjusted claims fell last weekly by a hefty 44,000, pulling the total down to 434,000. That’s a big retreat, and a welcome one--just in the nick of time. But the trend still looks ugly and the tally remains well above the 400,000 mark. Indeed, the four-week moving average for new claims inched higher to over 436,000. That’s the third installment of a four-week average number above 400k and it brings us back to the trend level in February, when worries about the economic outlook were somewhat stronger.
Today’s news that claims fell big time is surely encouraging. Anything less would have sent shivers down the crowd’s collective spine. But until (if?) we see more big retreats, and soon, the jury’s still out on what it all means. You don’t need much of an excuse these days to wonder about the prospects for economic growth and the biggest jump in jobless claims since the recession technically ended surely fits the bill. There's probably enough forward momentum to keep everything humming, but even modest confidence doesn't come easy.
Yet with job growth in the private sector showing no signs of reversal last month, it’s not obvious that the trouble in jobless claims warrants broader concern for the labor market. That is, unless the recent pop in new claims has legs. For the moment, however, we dodged a bullet, even if the battle rages on. Yes, we’re back to the week-to-week nail-biting of reading jobless claims numbers to tell us how much optimism (if any) is appropriate. Back to the future.
When jobless claims become a non-issue (i.e., when the reports are routinely running far below the 400,000 line), we can move on. For a time it looked like we’d jumped this statistical shark. The more things change…
But don’t despair. Mass layoffs for this year’s first quarter also posted a sharp drop from the previous quarter and the year-earlier period too. The rise in jobless claims generally in recent weeks doesn’t seem to be infecting other reports in the labor market. Let’s hope it stays that way. But if we see another cockroach, the mood's going to get a lot darker before it brightens.
Meantime, let’s be clear about where we stand in the grand scheme of things (as if we didn't already know). "Nine million jobs were lost in the recession, and we have added back only 1.8 million of those jobs in the past two years, which means that we still have a long way to go before labor markets can be described as healthy,” Cleveland Fed President Sandra Pianalto said in a speech today. "In April, the economy added 244,000 jobs, but the unemployment rate ticked back up to 9 percent. These numbers highlight the slow pace of improvement in the labor markets. Labor force participation is at low levels, which reflects a large number of discouraged workers who have simply given up on finding a job. I estimate that even at the end of 2013, the unemployment rate will be around 7 percent."
Inflation Expectations Retreat
Commodity prices have tumbled recently, and inflation expectations have been pared too, albeit only modestly. Is there a connection? Yes, or so it appears. But for the same reason that we should be cautious in reading too much into the inflation outlook based on a surge in prices of raw materials, the caveat applies when prices fall. Short-term commodity prices are too volatile to use as a lone source for gauging prospective inflation. Nonetheless, it's hard to overlook the recent shift in the Treasury market's forecast.
After hitting the recent peak of 2.63%, the inflation outlook based on yield spread between the nominal and inflation-indexed 10-year Treasuries dropped to 2.43% as of yesterday. That's a modest retreat from 2.63% reached at one point last month. But let's not oversell this change. Based on the last several years of trading data, an upper range of comfort appears to be in the neighborhood of 2.5%. A convincing move above that level for a sustained period would be a warning sign of some significance. For the moment, however, the market is telling us that inflation's threat looks subdued.
That's good news, or is it? With all the chatter about inflation's rising threat in recent months, the falling forecast is encouraging, right? To a degree. But if inflation continues to decline, at some point it would signal anxiety for the economic outlook. Recall that a year ago this month the market's inflation forecast fell sharply. At the time, I wondered if the trend was a clue that trouble was brewing. As it turned out, it was an early warning sign of the summer soft patch for the economy.
So far, the fading inflation forecast is mild this time around. Nonetheless, investors should keep a close eye on the trend in the coming weeks. The connection with lower commodity prices—oil's dip in particular—may be critical. The International Energy Agency trimmed its prediction for energy demand due to higher prices of late and a slower pace of economic growth in the developed world, TheStreet.com reports.
"The increase in inflation this year appears to reflect pressures that were largely the result of growing global demand and some supply-side or geopolitical shocks," Federal Reserve Bank of Atlanta President Dennis Lockhart advised in a speech yesterday. "The inflationary impact of some supply shocks is likely to be temporary. In fact, prices of several commodities have either leveled off or declined recently."
But too much of a good thing can bite back. The economic recovery has been modest at best. Meanwhile, there's a number of ongoing risks, including a fear that the real estate market may be headed for another rough spell… again.
For the moment, lower inflation expectations is a positive. But if this trend has legs, it may spell trouble. The outlook for growth still isn't strong enough to see lower inflation (or lower interest rates) at this stage as bullish. “Treasuries are supported by the general market angst about falling equities and concern over the U.S. economy,” Marc Ostwald, a fixed-income strategist at Monument Securities in London, tells Bloomberg today. “Today’s 30-year auction will be a reasonable test for the markets, given the low yield levels we’re at.”
May 11, 2011
Research Review | 5.11.2011 | Equal Weighted Portfolios
Update on MSCI Equal Weighted Indices
MSCI Research Bulletin | Dec. 2010
This paper illustrates the effect of equal weighting an index relative to a capitalization weighted index. An equal weighted index exhibits a small cap and value tilt, lower index concentration, and more stable sector weights. However, an equal weighted index has higher index turnover and lower investment capacity relative to a capitalization weighted index. Over the last twelve years (December 1998 to October 2010) the MSCI Equal Weighted Indices outperformed their capitalization weighted counterparts in the major countries and regions analyzed. This outperformance appears to be mainly driven by the small cap and value tilt, which are well-documented sources of excess return in financial literature.
Why Do Equally Weighted Portfolios Outperform Value Weighted Portfolios?
Yun Taek Pae (Lewis University) and Navid Sabbaghi (Illinois Institute of Tech.) | Sep 3, 2010
This paper suggests a number of implications for both academia and industry. First, equally weighted portfolios outperform value weighted portfolios in the effcient market. Our theoretical results are based on the Modigliani-Miller theorem and the Capital Asset Pricing Model. Since these two theories assume the effcient market, market ineffciency is not the only explanation for the positive return difference as suggested by the literature. Second, the return difference is not purely due to the weighting methods but is due to the positive market premium and tax shield. If the market premium is negative or firms in the portfolios are financially distressed, the results may not hold. Investors need to take the market premium and the financial structures of firms into account when they choose weighting methods. Third, the differences with respect to return, volatility, and correlation to the market premium between two weighting methods can be found with as little as 20 equities, or with fewer equities if they have varying market capitalization.
Beyond Cap-Weight: The Search for Efficient Beta
Rob Arnott (Research Affiliates), et al. | Nov. 16, 2009
For practitioners, the elegant simplicity of an equally weighted portfolio is compromised by implementation issues. Because Equal Weight means that we hold small companies on the same scale as large ones, the strategy results in higher transaction costs and lower capacity than Cap Weight. Still, absent trading costs and any view on forecasting return or risk, equal weighting has considerable appeal on a risk-return basis.One nuance that has received startlingly little attention in the academic and practitioner journals is: Equal weighting of what index? If Cap Weight has a bias towards including overvalued companies, then Equal Weight may exacerbate this bias. For instance, a clairvoyant might assert that the future prospects of 150 companies in the S&P 500 do not justify inclusion in the index. Their “clairvoyant value” market cap is too low. Because they will assuredly underperform eventually, they will pull down the S&P 500 return relative to our mythical clairvoyant value.
Equal Weight Indexing: Seven Years Later
Standard & Poor's | July 2010
Equal weighting is factor indifferent. It randomizes factor mispricing, and is thus an
attractive option for proponents of the theory that the market is inefficient and, at times,
misprices factors... Historically, the S&P Equal Weight Indices have outperformed their market cap weighted equivalents in the long-run. The level of performance has also varied considerably
under different market conditions... The outperformance of the S&P Equal Weight Indices is a result of the differing weighting and rebalancing processes. In terms of risk factor exposures, a complex and dynamic combination of size and style risk factors have contributed to the difference in returns. It may be difficult to replicate equal weighted index return outcomes through a simplistic combination of style and sector indices... Equal weighting demonstrates long term outperformance internationally... Criticism of equal weighted indices has centered on increased turnover and capacity constraints relative to market capitalization weighted indices. While true in abstract theory, neither is a serious hurdle in practice.
Portfolio Return Metric: Equal Weights Versus Value Weights
Kevin C.H. Chiang (University of Alaska) | May 22, 2002
Whereas the existing literature focuses on the relation between weighting schemes and abnormal portfolio return metrics, this study extends the literature and investigates the relation between weighting schemes and raw portfolio return metrics. We show that the equal-weight portfolio return metric systematically yields higher estimates of portfolio returns for event samples than the value-weight portfolio return metric. We also demonstrate that value-weight portfolio return metric can be a biased estimator of the counterpart of the population. These results imply that the commonly used testing procedure based on the matching portfolio method and the Fama-French three factor regression can produce misleading inferences. Several remedies are proposed in this study.
The Effect of Portfolio Weighting on Investment Performance Evaluation: The Case of Actively Managed Mutual Funds
Stanley Block (Texas Christian University) and Dan French (New Mexico State University) | Spring 2002 (Journal of Economics and Finance)
Among the factors influencing investment performance measurement is the weight dedicated to each security. This paper develops metrics for measuring the extent of equal weighting and value weighting of a portfolio. A sample of 506 actively managed mutual funds shows that funds tend to be equally weighted to a greater degree than they are value weighted, implying that investment performance based solely on a single value-weighted benchmark may not adequately identify excess performance. We propose a two-factor model utilizing both a value-weighted and an equally weighted index and show that the model provides a better fit than the singleindex model.
Improving Emerging Market Equity Performance through Equal-Weight Country Indexing
R. McFall Lamm, Jr. (Stelac Advisory Services) | Spring 2011 (Journal of Index Investing)
Capitalization-weight orthodoxy now dominates in the equity indexing world despite the fact that research indicates it is inefficient and underperforms valuation-indifferent approaches. However, a more important issue for multinational indices—especially in the case of emerging markets—is the method used to determine country weights. Pure cap-weighting allows country exposures to indiscriminately fall out of the bottom-up aggregation process, which significantly over-concentrates risk in only a few countries. This study demonstrates that employing an equal country weighting scheme for emerging markets would have hugely outperformed cap-weighting for the past quarter century. Equal weighting reduces risk by increasing diversification across divergent macro policy regimes and is mean–variance optimal in a special case. In contrast, cap-weighting forces investors into riskier exposure to overvalued markets and is mean–variance inefficient. Unfortunately, there are no equal-weighted broad emerging market indices or commercial products available. Using emerging market country ETFs offers a partial solution, although the full range of emerging markets is not covered and liquidity is sometimes limited.
May 10, 2011
Average Is Boring (And Competitive)
Jeff Troutner of Equius Partners laments that too many investment advisors too often succumb to the temptations of extreme and overly active portfolio strategies despite the rise of indexing. Indeed, he suggests that indexing has been hijacked and perverted. “Thousands of advisors, who long ago convinced themselves and their ever-changing clientele of their intellectual superiority over ‘the market’—only to be consistently humbled by it—have shifted their strategies from individual stock picking to ETF picking with a market timing overlay.”
Troutner’s worry is surely well founded. Academic research as well as anecdotal evidence suggest that a large percentage (a majority?) of individuals, financial planners and institutional investors who manage portfolios on the assumption that they’re smarter than average end up paying a price, particularly after deducting taxes and trading costs.
How to resolve this challenge? There are a thousand ways to approach the problem, but I believe that everyone should begin by considering the default portfolio that’s comprised of all the major asset classes weighted by market value. This is recurring topic on these pages, but a worthy one, in part because it’s so widely ignored. Most investors overlook this benchmark at their peril. Just as you should have some perspective on the baseball diamond you’re set to use for a game, it makes sense to understand the financial and commodity markets you’re intent on competing with as you build and manage an investment portfolio. For unknown reasons (or maybe they’re not so unknown), most investors overlook this critical point.
That includes overlooking the fact that a market-value index of everything (or at least all the major asset classes that are available as broadly defined ETFs) generates a competitive return over time. That’s no surprise. Indeed, more than half a century of financial research predicts no less.
For example, in an earlier post this month I updated my Global Market Index’s returns and compared it with the major asset classes. Over the past three years, for instance, GMI looks strong, or weak, depending on the individual asset class you pick for comparison. That’s always going to be the case, and it holds up over time.
More importantly, GMI is competitive with the various active asset allocation efforts. In fact, as I discussed recently, GMI’s trailing 10-year record has been well above average vs. more than 1,000 multi-asset class mutual funds over the past decade.
The point isn’t that everyone should pile into GMI or something comparable, although you could do a lot worse. Rather, the issue is considering the default portfolio as a first step in designing an asset allocation that's right for you. In short, the most important investment decision is deciding how to customize Mr. Market’s asset allocation. The second most important decision is deciding how to manage the mix through time. The second question is a far more complicated topic, of course, but the first step is pretty easy and, IMHO, intuitive.
One might wonder why the merits of a broadly defined passive asset allocation are so often overlooked if not dismissed. Troutner’s complaint that indexing is “boring” is probably a big part of the answer. Now it’s true that you can go overboard with boring as well. Even the greatest asset allocation in the world still needs adjusting through time. But that’s another subject entirely, although it doesn’t have much relevance if you flub the initial portfolio design.
Granted, there are no silver bullets here. The optimal portfolio mix is unknown for a simple reason: the future’s uncertain. What we do know is that GMI’s long-run performance is likely to be middling to slightly better than middling vs. all world’s efforts to enhance GMI’s average performance.
Alpha must sum to zero in the end. That inspires looking at a robust benchmark that holds everything in passive weights as a starting point. You can rationalize avoiding one or more of the asset classes; ditto for reweighting the allocations. But you shouldn’t do so out of ignorance or boredom. For most investors, unfortunately, that’s the typical response, which goes a long way in explaining why the average investor generally earns well below the average return of the market portfolio a la GMI.
May 9, 2011
What Are Econ Bloggers Thinking?
The Kauffman Foundation's released its new quarterly review of economic bloggers, which includes the two cents from yours truly. As a preview, the survey reports:
"Economics bloggers seem more pessimistic in their outlook on the U.S. economy than they were at the beginning of 2011, though 85 percent believe overall conditions are mixed, facing recession, or in recession. For an economy in which growth is the norm, 32 percent of respondents think that the U.S. economy is worse than official statistics indicate, and only 5 percent believe it is better. When asked to describe the economy using five adjectives, 'uncertain' remains the most frequently used term to describe the economy."
Back To The Rock & The Hard Place?
The stock market has been famously described as a discounting machine. The machine isn't flawless and so there's always a risk that the forecast du jour is misleading. But it's been right enough of the time to inspire monitoring Mr. Market's real-time outlook, if only as one of several tools for looking ahead. The first challenge is filtering out the noise in the short term. We can start by reviewing rolling 12-month percentage changes in equities and comparing that with the equivalent for the economic trend.
Consider how annual changes in the S&P 500 compare with a basket of leading economic indicators (for a list, see the table in this post). The ebb and flow of stock prices on an annual basis does a pretty good job of capturing major turning points in the economy. Unfortunately, it's rarely clear (if ever) when those turning points are in gear when evaluating conditions in real time. The best we can hope for is that the equity market offers an early clue of where the economy's headed after the major turning points.
For example, the 12-month change in the S&P 500 was clearly flashing a warning signal as 2008 unfolded. By the time of the financial crisis in Sep 2008 and beyond, the equity market had been telling us for months previous to be cautious. Meanwhile, the sharp revival in the S&P 500's rolling 12-month percentage change was flashing an early prediction of economic revival in the second-half of 2009. Recall that months later the recession was formally declared over as of June 2009 by NBER. According to the stock market, that was old news by the time the press release was published in September 2010.
For additional context, we can watch the market's trend relative to the economic reports that are thought to offer the strongest clues about the future. The difference between the stock market and the leading indicators is easier to see if we graphically measure the divergence alone, as per the second chart below. It's useful to note that in February 2010, on the eve of the spring/summer slowdown in the economy, the spread between the S&P 500's annual change and the leading indicators topped out. By the following August, this spread hit bottom, signaling a revival in the fortunes of the economy and the stock market.
As usual, there's a lot less clarity in trying to divine the future from current prices. All the more so when the market and the economic trend aren't at extremes. That means that a gray area dominates most of the time. Yet there's a fair amount of divergence in what the market seems to be forecasting and what the leading indicators are reporting these days. For the moment, the market continues to anticipate ongoing economic growth. By contrast, the pace is falling for the rolling 12-month change in the leading indices.
But there's no getting around the fact that this spread seems to be on the fence when it comes to dropping clues about the future. That's good news in the sense that Mr. Market hasn't thrown in the towel on the economic outlook. However, it would be an especially discouraging sign at this juncture if the stock market tumbles substantially from current levels. In that case, there'd be a new reason to worry.
For now, it seems safe to say that the market's taking last week's mixed economic news in stride. The stock market slipped last week, but only modestly, and with Friday's gain there's reason to think that the bulls are still in control. Despite discouraging news with initial jobless claims and the uptick in the jobless rate for April, the crowd seems inclined to see the glass as half full rather than half empty. Maybe that's because private-sector job growth last month was the strongest since the recession ended.
There's been no shortage of mixed messages on the economic front lately. No wonder that Mr. Market appears to be hedging his forecasting bets. The future is always uncertain, and sometimes it's more uncertain than usual. If history's a guide, forecasting will get a bit easier, for good or ill. But for now, fence-sitting is the sport du jour, although this too shall pass. Stay tuned…
May 7, 2011
Book Bits For Saturday: 5.7.2011
● From Financial Crisis to Global Recovery
By Padma Desai
Summary via publisher, Columbia University Press
Using the same presentation and detail that has earned her such wide-ranging acclaim for her previous books, Padma Desai explains in a course-friendly way the complexities of economic policy and financial reform. She merges a compelling narrative with scholarly research to teach and to engage the reader. Paul Krugman described Desai's 2003 volume, Financial Crisis, Contagion, and Containment: From Asia to Argentina, as the "best book yet on financial crises." Her most recent work on Russian reform was a "pick of 2006" by the Financial Times. Desai begins with a systematic breakdown of the factors leading to America's recent recession, describing the monetary policy, tax practices, subprime mortgage scandals, and lax regulation that contributed to crisis. She discusses the Treasury-Fed rescue deals that saved several financial institutions and the involvement of Congress in passing restorative policies.
● Out of the Box and onto Wall Street: Unorthodox Insights on Investments and the Economy
By Mark Grant
Summary via publisher, Wiley
Part memoir, part investment strategy guide, Out of the Box and onto Wall Street presents a revolutionary, alternative look at the world of finance. Revealing the essential rules for preserving capital and making long-term profits, the book provides timely observations on the current and future state of the world economy and investment markets, which are sure to be of interest to anyone considering alternative and time proven ways of making money.
● The Big Thirst: The Secret Life and Turbulent Future of Water
By Charles Fishman
Review via NPR
In The Big Thirst, Fishman examines different areas of the world already grappling with water shortages. He profiles parts of Delhi, India, where people line up twice a day with buckets for clean water, and Las Vegas — which, despite having all forms of water entertainment for visitors, is currently dealing with one of the biggest water shortages in the nation... In the next 30 years, Fishman predicts, private companies will develop the technology to make water utility plants more efficient. But, he cautions, it's important to make sure water remains a public resource. "You don't want to let companies end up in control of the resource itself," he says. "We need to be careful not to cede those rights ... while we also take advantage of the innovations. That's a question of making sure that we understand the economics and policies on a community-by-community basis. There's nothing wrong with companies innovating [solutions for] water as long as the water remains a public resource. And that's really important."
● Wealth Management: The Financial Advisor's Guide to Investing and Managing Client Assets
By Harold Evensky, Stephen M. Horan, Thomas Robinson, and Roger Ibbotson
Summary via publisher, Wiley
For over a decade, The New Wealth Management: The Financial Advisor's Guide to Managing and Investing Client Assets has provided financial planners with detailed, step-by-step guidance on developing an optimal asset allocation policy for their clients. And, it did so without resorting to simplistic model portfolios, such as lifecycle models or black box solutions. Today, while The New Wealth Management still provides a thorough background on investment theories, and includes many ready to use client presentations and questionnaires, the guide is newly updated to meet twenty-first century investment challenges.
● The WSJ Guide to the 50 Economic Indicators That Really Matter: From Big Macs to "Zombie Banks," the Indicators Smart Investors Watch to Beat the Market
By Simon Constable and Robert E. Wright
Summary via publisher, Harper Collins
The Wall Street Journal Guide to the 50 Economic Indicators that Really Matter is a must-have guide for investors. Dow Jones columnist Simon Constable and respected financial historian Robert E. Wright offer valuable tips and insight to help investors forecast and exploit sea changes in the global macroeconomic climate. Unlike other investment handbooks, Constable and Wright’s guide explores the not widely known economic indicators that the smartest investors watch closely in order to beat the stock market—from “Big Macs” to “Zombie Banks.” Not only valuable and informative, The Wall Street Journal Guide to the 50 Economic Indicators that Really Matter is also wonderfully irreverent and endlessly entertaining, making it the most fun to read investors’ guide on the market.
● Corporate Governance Failures: The Role of Institutional Investors in the Global Financial Crisis
Edited by James P. Hawley, Shyam J. Kamath, and Andrew T. Williams
Summary via publisher, University of Pennsylvania Press
Corporate governance, the internal policies and leadership that guide the actions of corporations, played a major part in the recent global financial crisis. While much blame has been targeted at compensation arrangements that rewarded extreme risk-taking but did not punish failure, the performance of large, supposedly sophisticated institutional investors in this crisis has gone for the most part unexamined. Shareholding organizations, such as pension funds and mutual funds, hold considerable sway over the financial industry from Wall Street to the City of London. Corporate Governance Failures: The Role of Institutional Investors in the Global Financial Crisis exposes the misdeeds and lapses of these institutional investors leading up to the recent economic meltdown. In this collection of original essays, edited by pioneers in the field of fiduciary capitalism, top legal and financial practitioners and researchers discuss detrimental actions and inaction of institutional investors. Corporate Governance Failures reveals how these organizations exposed themselves and their clientele to extremely complex financial instruments, such as credit default swaps, through investments in hedge and private equity funds as well as more traditional equity investments in large financial institutions. The book's contributors critique fund executives for tolerating the "pursuit of alpha" culture that led managers to pursue risky financial strategies in hopes of outperforming the market. The volume also points out how and why institutional investors failed to effectively monitor such volatile investments, ignoring relatively well-established corporate governance principles and best practices.
● The Constitution of Liberty: The Definitive Edition (The Collected Works of F. A. Hayek)
By F. A. Hayek (edited by Ronald Hamowy)
Review via The New York Times Book Review
In an age when many on the right are worried that the Obama administration’s reform of health care is leading us toward socialism, Hayek’s warnings from the mid-20th century about society’s slide toward despotism, and his principled defense of a minimal state, have found strong political resonance. The new edition of “The Constitution of Liberty,” which was first published in 1960, differs from the original primarily insofar as the extensive endnotes in the original edition have now been placed at the bottom of the page and heavily annotated by the editor, Ronald Hamowy...Hayek’s skepticism about the effects of “big government” are rooted in an epistemological observation summarized in a 1945 article called “The Uses of Knowledge in Society.” There he argued that most of the knowledge in a modern economy was local in nature, and hence unavailable to central planners. The brilliance of a market economy was that it allocated resources through the decentralized decisions of a myriad of buyers and sellers who interacted on the basis of their own particular knowledge. The market was a form of “spontaneous order,” which was far superior to planned societies based on the hubris of Cartesian rationalism.
May 6, 2011
April Job Growth Improves As Jobless Rate Ticks Up
This morning’s update on nonfarm payrolls for April brings some good news. Job growth accelerated last month to a net rise of 268,000 (seasonally adjusted) vs. March’s 231,000 gain. In fact, April’s pop was the best monthly increase in payrolls since the recession ended.
The news is all the more satisfying in the wake of Wednesday’s weak ADP jobs report, and yesterday’s rising trend in jobless claims. Economists were surprised as well: the consensus forecast called for a gain of 200,000, according to Briefing.com.
Jim O’Sullivan, chief economist at MF Global opines that there's a fair amount of growth momentum to consider. “The recovery has progressed into the self-propelling stage, where it’s less vulnerable to short-term swings in sentiment,” he tells Bloomberg.
Perhaps, but we should be cautious with today’s jobs report for several reasons. One is that most of the surprisingly good news comes via a sharp revival in retail employment. In March, retail jobs suffered a rare retreat, dropping by a seasonally adjusted 3,200 on a net basis. The dip was temporary, however, and last month the sector added more than 57,000 positions—the biggest monthly gain by far in more than three years.
Retail jobs are certainly welcome—indeed, any job growth is good news these days. But it’s misleading to think that retail employment will bail us out at this pace for an extended period. In addition, one might wonder if retail jobs offer the same kick for economic growth vs. employment gains in other sectors, such as housing and manufacturing.
In any case, let’s not look at gift horse in the mouth. Meantime, let’s also note that despite today’s jump in job growth, the unemployment rate ticked back up to 9.0% for April.
There's also the much-weaker household employment survey to consider. The methodology for this series is different than the more widely monitored establishment survey that's noted above. Indeed, as we discussed earlier this year, the household survey employment numbers are quite a bit more volatile vs. their counterparts derived from the establishment report. Accordingly, the two series can and do differ from month to month by more than trivial amounts. Nonetheless, no one will take from comfort from learning that civilian employment via the household data dropped by a hefty 190,000 last month after posting a 291,000 net gain in March.
It seems that there's still plenty to worry about. In other words, not much has changed. The economy is still growing and the labor market is recovering, but the pace of growth isn’t enough to bring down the unemployment rate quickly. Today’s payrolls report offers another reason for thinking that the risk of a new recession is still relatively low (at least according to the establishment survey). Yet the threat of a slowing recovery from an already sluggish pace can’t be ruled out.
What Are Commodity Prices Telling Us Now?
Yesterday's selling wave that slashed commodities prices is a reminder that this is a volatile asset class and so its value is limited as an input for setting monetary policy. Once again, we have a real-world lesson in why central banks focus on core inflation, which strips out food and energy prices. It's hardly reasonable to ignore commodities in monitoring future inflation expectations, but it's easy to go overboard with reading too much into raw materials prices.
Recent history surely offers a lesson in humility on this point. Back in mid-2008, when the Great Recession was well under way (even though it wasn't yet obvious to all), the trailing 12-month percentage change in headline consumer price inflation was elevated at north of 5%--more than double the rate from a year earlier. Headline inflation includes food and energy prices, and the message seemed to be that inflation was set for a sustained run higher. In fact, it collapsed shortly after, descending into a bout of deflation.
Should we have been skeptical of headline inflation's warning signal? Yes, because core inflation (the red line in the chart above) remained relatively stable during the 2007-2008 surge in headline CPI.
That brings us to yesterday's collapse in commodities prices. The cash price of oil (West Texas Intermediate), for instance, dropped under $100 a barrel on Thursday, down from nearly $115 a few days earlier. Now it's possible that prices could just as easily run higher in short order. But that's the point: the nature of commodities is volatility, and seemingly small bits of news can trigger big moves.
That's a problem for setting monetary policy, which has no choice but to work with long lag times. That inspires looking beyond commodity prices for clues about future inflation. An obvious place to start is with the bond market, and here we find that the latest signal remains relatively subdued. The market's inflation outlook, based on the yield spread between the 10-year nominal and inflation-indexed Treasuries, slipped under 2.5% yesterday. That's roughly where it was three years ago, on the eve of the financial crisis that roiled markets and economies the world over.
Ah, but isn't the rise in inflation expectations from lesser levels in recent months a sign that pricing pressures are becoming threatening? Not necessarily. Recall that the Fed's QE2 stimulus program launched late last year was intent on boosting inflation expectations, albeit modestly, and on that score one can say that the program has been a success. Sitting idle and watching inflation expectations rise from current levels would be a mistake, but for the moment, at least, it's not obvious that the crowd is worried about a new round of higher prices.
The danger is that commodity prices resume an uptrend for the long haul, which could lay the groundwork for higher inflation that's more than transitory. But as Paul Krugman notes, even if you think commodity prices are set to double over the next decade, that would add a modest 50 basis points to inflation's pace. Why? As data from the San Francisco Fed shows, commodities represent a "small" slice of personal consumption expenditures--roughly 5%.
Let's recognize, too, that yesterday's rising trend in new jobless claims further weakens the case for thinking that inflation's set to surge higher. The commodity markets seemed to have taken the hint, but the jury's still out on the inflation hawks who've been arguing that the Fed should start hiking interest rates… NOW.
There's a reason that the economics literature advises that core inflation is a better measure vs. headline. Monetary economists didn't dream this idea up out of the blue. Rather, it's knowledge formed over decades of analysis of how prices and macroeconomics interact. Facts are still stubborn things.
May 5, 2011
Initial Jobless Claims Surge To 8-Month High
The news in this morning’s update on new weekly jobless claims is bad. In fact, it’s the worst report for this series since the recession ended in mid-2009. The Labor Department argues, according to Bloomberg, that the unusually big jump in claims was due to “auto-plant shutdowns and other unusual events that seasonal variations failed to take into account.” In any case, new filings for unemployment benefits surged last week by a seasonally adjusted 43,000--the biggest weekly jump in more than two years. As a result, claims hit 474,000 for the week through April 30, the highest since last August.
Dismissing this as meaningless volatility isn't going to be easy until (or if) we see much lower numbers in the weeks ahead. One reason for reserving judgment is the disturbing trend over the past month for this series. For all the talk that the latest number is an outlier, there’s no getting around the fact that the trend over the last several months hasn’t been kind for thinking optimistically. As the chart below reminds, initial claims have been more or less rising since the end of February—steeply and sharply so since early April. The four-week moving average, which filters out a fair amount of the weekly noise, has taken wing as well and is now at its highest since last November.
It seems that the labor market has hit a new round of turbulence. Maybe last week was unusually harsh, but for the moment there’s only hope that lesser numbers are coming. Meantime, it’s debatable what’s causing the rise in the newly unemployed in recent weeks. Nor has the blowback shown up in monthly payrolls numbers yet—or has it? Yesterday’s ADP Employment Report for April was relatively weak. Today’s jobless claims report suggests we should brace ourselves for more disappointing news on the labor market.
It’s all about jobs…again. Nearly a year’s progress in falling jobless claims has been wiped out in a month. That’s no statistical anomaly. Something’s gone wrong with the labor market recovery, which wasn't all that robust to begin with. In turn, there's a new dark shadow over the prospects for the broader economy. It's too early to say where all this is going, but the numbers aren't giving us any slack for the time being. Until further notice, the crowd will be filtering every economic data point through the lens of the employment picture.
In searching for explanations, sharply higher gasoline prices are at the top of the list of suspects. Meanwhile, Reuters reports:
A Labor Department official attributed the surprise surge in claims last week to spring break layoffs in New York, which added 25,000, and the start of an emergency benefits program in Oregon, which brought in new claimants, including some already on the regular programs.
There were also additional claims from the auto sector, the official said, adding that there could have been some small claims related to the tornadoes that struck parts of the country. However, he said such claims would normally go into a parallel program.
The AP reports the same via NPR:
A [Labor] department spokesman blamed much of the increase on an unexpected spike in applications from New York, where more school systems than usual closed for spring break last week. That resulted in 25,000 layoffs. The department didn't anticipate the closures when making seasonal adjustments, the spokesman said.
This much is clear: until and if the weekly jobless claims reverses, there’s apt to be a lot more skepticism about the economic outlook. It’s going to be a long week between now and next Thursday’s follow-up claims report. For what it’s worth, I’m expecting the labor market, and the economy, to continue struggling but still maintain modest growth. But as today’s news reminds, even this middling outlook, which I’ve held for some time, is destined to be rattled on a regular basis. Keeping the faith in the cyclical gods, in short, isn’t getting any easier.
It's always been a fragile recovery and it remains so today, although It's still a recovery. It's premature to expect a new recession. The risk, however, is higher, if only at the margins. Then again, assessing such things is fluid, as they say. Evaluating the uncertainty of the future by looking in rear-view mirrors has always been a flawed way to fly. Alas, beggars can't be choosy.
May 4, 2011
ADP: April Private Payrolls Rise, But At Slowest Pace In Months
It’s still growing, but job creation slowed last month, according to today’s release of the ADP Employment Report. Nonfarm private jobs rose by 179,000 in April on a seasonally adjusted basis--down from March's gain of 207,000. That’s strong enough to offer convincing evidence that the labor market is still expanding with enough forward momentum to keep the party going in the months ahead. But it’s also true that last month’s gain was the smallest since last November’s tepid 122,000 rise.
Nonetheless, the labor market has expanded for 15 straight months, based on ADP numbers. Private-sector employment is higher by more than 1.6 million since the end of January 2010. That’s a lot of jobs in the abstract, although it’s still a small fraction of the 7.8 million jobs lost in the Great Recession, as per ADP’s reckoning.
The implication in today’s ADP report is that the U.S. unemployment rate for April, as per the government's update scheduled for release on Friday, will show little if any decline from the elevated 8.8% rate reported for March. If we compare ADP’s employment figures with the Labor Department’s establishment survey tally of private job growth recently, today’s report suggests that Friday’s payroll update will be relatively weak too.
As the second chart below suggests, the government’s numbers have been a bit strong over the last several months compared with ADP’s estimates. That’s no guarantee that Friday’s number will be weak, but given the recent uptick in new jobless claims there’s reason for caution on expecting a robust upswing in job growth at the moment.
Paring expectations already appears built into expectations for Friday's report. The consensus forecast from economists calls for a rise of 200,000 private-sector jobs in the coming government update, according to Briefing.com. If that proves accurate, it would represent a sizable downshift from March's 230,000 gain.
Sizable but hardly fatal. The labor market is still growing; while it's far from what's needed to make a major dent in the jobless rate, it's still strong enough to keep talk at the margins for a repeat performance of last year's spring/summer economic slowdown that seemed to threaten a new recession. Indeed, last month's 179,000 rise in private-sector jobs via ADP is substantially higher than the year-earlier gain of 113,000 in April 2010. And while we don't yet have the government's latest tally for last month, the March 2011 rise of 230,000 for private payrolls based on Labor Department's estimates is nearly 60% higher than the comparable figure from a year previous.
In short, job growth is stronger this spring vs. last year. There's no law that says this must continue, but the trend compares favorably for the moment. That's no silver bullet, but it's something. But as Steven Ricchiuto, chief economist at Mizuho Securities USA, reminds via Bloomberg today: “This pace [of job growth] keeps things moving forward but not at a strong enough growth rate to really, really improve labor market conditions and improve the economy. The labor market is still underperforming the expectations where growth will be and should be at this point.”
May 3, 2011
Talking About Monetary Policy & The Economy
I'll be one of five panelists chatting up the outlook for the economy in tomorrow's teleconference at noon eastern hosted by Focus. Here are the details on how to listen in...
The March Rebound
All the major economic reports for March are in and it’s clear that the setback in February was reversed, and then some.
Our equally weighted index of 18 U.S. economic indicators rose 1.1% in March, more than reversing February’s 0.8% drop. That pushes our composite indicator of U.S. economic activity to a new post-recession high, as the chart below shows.
Here’s how the numbers stack up individually:
Reviewing the composite and leading measures of our economic benchmarks on a rolling 12-month basis reveals that the upside momentum is slowing. That’s normal, of course. The extraordinary rebound in relative terms after the recession’s end was destined to downshift. Nonetheless, the slowing in the broad trend is a reminder that the strength that usually accompanies the early stages of post-recession periods is now history. The cycle is entering middle age.
The good news is that broad trend in the economy appears to have forward momentum. The first economic number for April suggests as much. Yesterday’s update on the ISM Manufacturing Index continues to paint an encouraging picture. As Brian Wesbury, economist at First Trust, observes:
Manufacturing continues to boom, with the ISM index coming in at 60.4 in April. The index has now been over 60 for four straight months and the four-month average of 60.9 is the strongest since 1984, when the economy was in the huge 1980s recovery.
Even so, all the usual risks are still with us, starting with questions about the power and persistence of job growth. Although private nonfarm payrolls have been growing steadily for more than a year, the pace of expansion has been modest relative to what’s required to bring down the elevated jobless rate. Based on expectations for this coming Friday’s jobs report for April, most economists are anticipating more of the same. Meanwhile, in the wake of last week’s disturbing rise in new filings for jobless benefits, anxiety about the labor market isn’t set to fade any time soon.
Yes, it appears that the expansion will roll on, but it still comes with a lot of baggage.
May 2, 2011
The Bulls Of April
April was a foolproof month for investing. All the major asset classes posted handsome gains last month, leaving no room for excuses for active strategies that stumbled.
Leading the charge higher: foreign stocks in developed markets in U.S. dollar terms. The MSCI EAFE Index's total return was a strong 6% last month, its best monthly performance this year and twice the 3% pop for U.S. stocks (Russell 3000) in April. A fair amount of the gain in foreign equities, however, was due to the dollar's decline. The U.S. Dollar Index tumbled 3.9% last month, its steepest descent in a calendar month in nearly a year.
Whatever the fallout from the greenback's dive, it wasn't obvious in broadly defined asset classes last month. Risk paid off in nearly every corner of the capital and commodity markets in broadly defined terms in April. The last time everything popped was last October.
Unsurprisingly, our passively weighted benchmark of all the major asset classes earned a strong 3.5% last month—its best showing since December's 4.8% gain. For the year so far, the Global Market Index (GMI) is up 7% on a total return basis. The trend is even stronger over the past 12 months, with GMI climbing by nearly 16%, thanks to the fact that double-digit gains dominate the performance summary for individual asset classes for year through April 31.
In other words, betas are giving actively managed asset allocation strategies a competitive run once more.