It’s unclear how much of the game plan he’ll reveal, if any, but the pressure promises to be high for spilling the beans, or at least throwing out a bone.
Talking in abstractions about monetary policy and inflation targets won’t satisfy politicians this time around. It never did, and isn’t about to start now. Nonetheless, that may be all they get when Ben Bernanke fields questions for his debut grilling as Fed chairman on Capitol Hill tomorrow. Among the sea of inquiries that will no doubt get tossed at him, one we’d like to see earn some lip service is exploring Bernanke’s thinking (now that he’s in the driver’s seat) on the connection, real or perceived, between inflation and wages/employment when it comes to grinding out monetary policy decisions.
It’s a topical question, considering that unemployment’s fallen to 4.7% in December, the lowest since July 2001. Meanwhile, wages are growing nearly as fast as top-line inflation, measured by average hourly earnings and consumer prices, respectively. Using core CPI, which subtracts food and energy from the mix, wages are advancing at a considerably faster rate than inflation. All of which coincides with questions over the next move in the Fed’s monetary policy, namely, will the central bank soon declare inflation sufficiently contained and thereby end the current round of interest-rate hikes?
Monthly Archives: February 2006
BONDING IN A BULL MARKET
Merrill Lynch is reportedly in talks to acquire a 50% slice of BlackRock, well known for its bond funds although it manages equity too. Merrill’s coup is said to come at the expense of Morgan Stanley, which also tried but failed to get a piece of this rock.
If there’s any confusion as to what makes BlackRock so attractive, a quick look at the fixed-income manager’s stock price will alleviate any stupefaction. Indeed, soaring share prices usually explain any frenzy over asset buying.
As it happens, there’s been no shortage of ascending performance in fixed-income land of late. Just ask the managers of Loomis Sayles Strategic Income, a mutual fund that searches the globe for alluring bonds, a strategy that’s fueled the mutual fund with a three-year annualized total return of more than 16% through the end of last year, according to Morningstar. That beats the Lehman Brothers Global Aggregate bond index’s 5.5% over that span, as well as the S&P 500’s 14.4% run. Everyone loves a winner, and some want to own it when it’s hot. Long live momentum.
BlackRock’s no slouch in cashing in on the bull market in bonds. As a business, the times could hardly be more flush for the firm. That said, the cat’s long been out of the bag on this score. The company’s shares are up more than 60% over the past year, more than ten fold higher than the stock market’s return over that span, based on the S&P 500, reports Yahoo Finance. BlackRock’s stock is no recent arrival to its bull market, having soared some ten-fold over the past six years as well.
It’s also no great mystery what’s behind BlackRock’s success. Bond yields remain relatively low of late, after having fallen for the better part of a generation. What’s not to like? Falling followed by relatively stable low yields is a bond manager’s claim to fame in the 21st century. Accordingly, net income for the fixed-income manager has climbed more than 290% in 2005 from 1999, mirroring the fortunes that accompany life among the fixed-income set when yields fall and don’t get up.
But if it’s a great time to buy bond managers, along with bonds, using rear-view mirrors, how will the purchase square with the years ahead? If the BlackRock acquisition is deemed a savvy move today, with the yield on then 10-year Treasury under 4.6%, how might the transaction be described several years hence if yields are materially higher?
The answer depends on your expectations for the price of money. To wit, do you expect inflation, deflation, or something in between, and how much? We can surmise Merrill’s forecast.
THE 30-YEAR QUESTION
We know why they’re selling it. The question is, why are they buying it?
The “it” here is the 30-year Treasury bond, which returned to the capital markets after a four-and-a-half year respite. By all accounts, the security’s return was a rousing success, at least for the government. Buyers were crawling over each other to grab a slice of government debt whose principal won’t be returned until 2036. Bloomberg News reports that yesterday’s bidding was such that the yield fell to 4.53%, the lowest on record for a 30-year Treasury.
CASH COWS
The world is awash in liquidity, and that includes central bank coffers. Using IMF’s numbers, the monthly tally of international reserves at central banks around the world shows liquidity rising by 2.5% to a record high in the 12 months through December 2005.
Where is all this central bank liquidity going? Presumably, a fair chunk of it winds up in dollars. In fact, the buck has been climbing once again, giving support to the notion that central banks continue to park reserves in the world’s lone reserve currency. The gloom that hung over the greenback in January has since lifted, with the U.S. Dollar Index rising 2.6% since the selloff on January 23.
DIRTY DATA DANCING
The yield curve has inverted again, raising fears anew that a recession may be in the cards after all (or is that just another reverberation from the global savings glut that Fed Chariman Bernanke likes to talk about?) In any case, the 10-year Treasury’s yield of 4.56% in mid-morning was trading below the 2-year’s 4.61%. The inversion is all the more striking coming after last week’s batch of economic releases that suggested that the economy was still growing at a healthy clip in spite of the surprisingly low rate of growth posted in the first estimate of fourth-quarter GDP.
STUMBLE ALERT
Earnings estimates are suffering from a bout of weakness these days, writes Michael Krause of AltaVista Independent Research, a New York consultancy that specializes in fundamental analysis of exchange traded funds, or ETFs. In a newly minted report, Krause observes that for 2006 forecasts “we are seeing sustained and accelerating revisions to the downside. Over the past month, 2006 estimates for seven out of nine sectors declined….” He adds that the slide is “the fastest rate of decline since we began monitoring 2006 estimates back in July 2005.”
Krause’s report comes at an anxious moment, given all the debate about whether the economy is, or isn’t poised for a stumble. Indeed, the mixed signals emanating from recent economic releases has Wall Street abuzz about what comes next for the stock market. In search of clues, we interviewed Krause via email….
In your latest research report, you write that “we are seeing sustained and accelerating revisions to the downside.” Give us an overview of what’s going on. Is the earnings cycle finally turning?
We still expect that S&P 500 earnings will increase this year. What’s different is that expectations are now on the decline, whereas for the past two years estimate revisions were almost universally positive, even excluding the effect of Energy earnings on the S&P, which everyone recognizes played a big part.
The accompanying graph (see below) illustrates the trend in 2006 earnings estimates since July of last year. Estimates for the S&P 500 as a whole rose through November and then started to decline. But excluding Energy, estimates that had remained stable through last summer began to weaken in the fall and have started to decline at a faster rate more recently.
Historically, trends in estimates revisions tend to persist for some time. That is, they don’t haphazardly move up/down from month to month, so the downward trend, now established, could well continue. After two years of being behind the ball on the strength of corporate earnings, Wall Street analysts might now be too optimistic at a time when earnings growth is quite naturally slowing in this, the fifth year of a profit recovery.
However, the fact that Wall Street gets its numbers wrong need not spell doom for the market. Even if negative estimates revisions were to continue apace, S&P 500 earnings would likely end the year up around 6%. That’s not as high as the 11.4% suggested by current consensus estimates, but still in-line with the post-WWII average of 6.2%.
NEW BUT NOT NECESSARILY IMPROVED
Thirty years is a long time, but is it too long for comfort these days? The folks at Treasury think not, or at least that’s the implied message that will come packaged in the revived 30-year bond, which debuts anew on Thursday.
In August 2001, when we last glimpsed the government issuing new debt with a life span of three decades, the world looked a bit different. For starters, the tragedy of 9.11 was still a concept in a few twisted minds, and so a bit of innocence (or gullibility?) still defined the investment psyche on conjuring the risk factors that could arise on a moment’s notice. Meanwhile, inflation in August 2001 was running at a relatively mild 2.7% annual rate, based on the government’s consumer price index.
In February 2006, fewer investors harbor illusions about the risks that potentially lurk in the foreseeable future. Those risks can cut either for or against the fortunes of bond values, which is to say that winds of inflation or perhaps disinflation could blow harder at a moemnt’s notice. The former, however, seems to have the upper hand at the moment.
Indeed, inflation (the only potential threat to an otherwise “safe” government bond) is a bit higher now than when the 30-year bond last made an appearance. Consumer prices are rising by 3.4%, according to the annualized rate posted in December. Inflation’s pace, in other words, is roughly one-quarter more than it was when the Treasury last sold its paper embedded with 30-year maturities.
THE PLOT THICKENS (AGAIN)
Today’s employment report for January strikes yet another blow at the forces of pessimism emboldened by last week’s surprisingly weak fourth quarter economic news. Indeed, this week’s news on the economy has been generally upbeat, offering a sharp counterpoint to last Friday’s disappointing GDP release. But there’s a catch: the encouraging update on the employment front comes at an anxious time for inflation expectations, which are on the rise, or so the ongoing bull market in gold suggests.
Sticking with jobs for the moment, it’s a bit easier to be cheery about growth this morning. The Labor Department advises that the jobless rate last month fell to 4.7%, the lowest since July 2001. The economy created 193,000 new jobs in January, up from December’s relatively sluggish pace of 140,000. Although November’s revised sizzling pace of a 354,000 gain seems a world away, it’s nonetheless clear that the American economy’s ability to mint new employment opportunities is far from dead in 2006. Indeed, last month marks the 29th straight month of growth in new jobs. The previous stretch of unbroken gains was the 33 months through May 2000 (the run would have been 52 months had it not been for August 1997’s mild stumble, but we digress).
Adding to potency of January’s employment momentum is the fact that the rise was broadly dispersed. Even the perennially job-challenged manufacturing sector managed to eke out a gain of 7,000 new jobs last month. Only retail trade and government posted losses, albeit relatively slight ones at that.
SELECTIVE REASONING
It’s too early to say what trend will define the Bernanke era of central banking, but the bull market in gold may get a footnote or two once the final history is written. Indeed, the precious metal is soaring, suggesting that something less than unwavering faith prevails when assessing the odds of success among mortal beings charged with defending the integrity of paper currencies.
As of yesterday’s close, gold has climbed 10% so far in 2006. Catalysts driving the metal higher come in two basic flavors: geopolitical and economic. The obvious suspects in the former include rising anxiety over any number of Middle East tensions (Iran’s nuclear program, Hamas’ election in Palestine, the ongoing terrorism in Iraq, etc.) The economic worries start with the red ink that defines America’s budget and trade ledgers, and move on to the ongoing elevation in the price of oil, which some say portends higher inflation.
WILL THE REAL ECONOMY PLEASE STAND UP?
On the first day of the newly minted Bernanke era, the pressing question is whether the economy’s slowing, and if so, is it slowing more than a little?
The topic returned to the limelight last week when the first estimate of the nation’s gross domestic product surprised with a sharply lower rate of growth than the dismal science was expecting. Optimists quickly responded that something was rotten in the data, and that future revisions of GDP would return the official measure of the economy’s pace to form, namely, robust growth.
Judging by consumer spending of late, the optimists have reason to cheer. As the government reported on Monday, Joe Sixpack and his friends are in no mood to reign in their spendthrift ways. Personal consumption rose a strong 0.9% in December, as it did in November, based on revised numbers. Back-to-back strength, in no uncertain terms. Take that, you pessimists. Underscoring the trend is the fact that durable goods purchases were in the driver’s seat for pushing overall consumption higher in the final two months of 2005.
If a sharp slowdown, or worse, is coming, Joe seems cheerfully oblivious to the threat. As such, one might wonder if a slowdown is probable, or even possible if Joe and his buddies aren’t on board with the idea. Personal consumption spending, after all, represents around 70% of GDP. As goes consumers’ willingness to use the heralded credit card, so goes the economy.