The main point of optimism in yesterday’s first reading of Q1 GDP is the jump in consumer spending. But as today’s update on personal income and expenditures for March reminds, there’s still quite a bit of uncertainty left as to whether consumption is truly on the mend.
Much of what registered as increased consumer spending in this year’s first quarter came in January. A convincing follow-through still awaits. As our chart below shows, the bump just ahead of March 2009 was a first-of-the-year rise in both disposable income and personal consumption spending. It was a welcome reprieve from the crushing setback in late 2008. But the trend is fading and last month’s consumption dropped relative to February. Disposable income, meanwhile, was flat in March.
The main question is whether the realities of the broader economic climate are finally weighing on American households as they ponder the toxic combination of falling housing values, fewer jobs, higher unemployment and burdensome debt levels built up over the years. The government’s massive stimulus efforts over the past year have helped slow the tide, but the correction in consumption and consumer attitudes will roll on.
Adding to the challenge is the recent uptick in the 10-year yield. The Fed has been working overtime in trying to keep long rates low, which is to say below 3%. But now Mr. Market is rebelling. The 10-year closed above 3% for the third day running yesterday. That’s the first time it’s run above that level since the Fed announced on March 18 that it would buy long-dated Treasuries outright in order to keep rates low. Immediately following the news, the 10-year yield dropped by an extraordinarily steep 50 basis points to around 2.5%. Now the yield’s above 3%. And the higher rates come at a time with little or no worries about inflation.
Of course, one could argue that the apparent topping out in new jobless claims suggests that the recession may be at or near a trough. We’ve suggested as much recently, including here, and our reasoning is here. And today’s update on new filings for jobless benefits offers a fresh datapoint to argue that the business cycle may have bottomed.
But we must distinguish between a bottom to the recession and the renewal of economic growth. If we have an “L” recession, the bottom could last qiute a bit longer than the crowd expects. All the more so given the depth and magnitude of the current downturn.
In short, there’s reason for optimism and its counterpart. Deciding which one has the upper hand will still take more time.
Monthly Archives: April 2009
ANOTHER PAINFUL GDP REPORT
The government’s advance estimate of GDP for the first quarter was worse than expected—quite a bit worse. The consensus outlook called for a 4.7% drop, according to Briefing.com, but the government says the decline was -6.1%.
The good news is that GDP reports are old news, and so today’s dire numbers have already been digested in various reports in past weeks and months. But there’s always the future, and it’s debatable how much has changed in April, or is set to change in May.
Meanwhile, it’s clear that the U.S. economy’s performance for January through March was quite grim. The 6.1% drop in real annualized GDP for Q1 was just below the 6.3% fall for 2008 Q4. Both numbers are among the steepest quarterly declines in 50 years. The fact that the two came back to back only makes matters worse. The question is what’s in store for Q2?
DIVING INTO THE NUMBERS
The “long run” isn’t everything, but it’s something, which is to say it’s relevant. Studying it, then, is productive. It shouldn’t dominate decisions for designing and managing asset allocation, but it’s a great place to start.
The long run is everywhere when perusing the latest edition of Ibbotson SBBI 2009 Classic Yearbook. For the uninitiated, the book is a feast of data, reviewing all the usual measures of stocks, bonds and now REITs and a touch of commodities. Here is the epitome of slicing and dicing the numbers when it comes to investment research, at least when defined in the dead-tree medium. You’re not really familiar with the trends and the profiles of the major asset classes until you’ve spent some time poring over SBBI.
THE PEAK STILL HOLDS
It’s too soon to declare that the worst of the recession has passed, but it’s also premature to dismiss the idea. We are, in short, in a never-never land of waiting and watching, and this game may roll on for many a moon.
To help pass the time, we’re watching the data as it comes in, including initial jobless claims. As we’ve written, this is one of several metrics that may offer clues about when the business cycle reaches a trough. Like any one statistic, it can’t be fully trusted, and so we must look to a range of data points. But history suggests that as single measures of broad economic trends go, this one’s unusually useful in trying to peer into the future, or so it’s been in the past.
DEFENDING DIVERSIFICATION
After the huge losses in markets last year, the long knives have come out on diversification.
It seems that everyone now shuns the idea of owning multiple asset classes. Curiously, no one was complaining in 2002-2007, when bull markets prevailed in just about everything. Of course, the crowd has a habit of promoting (or remaining quiet when it comes to critical comments) about strategies that are working in real time. After the fact, it’s all a bunch of hogwash. So be it. That’s the nature of finance: History, and what passes for intelligent counsel, is constantly being rewritten to suit the moment.
IS THE TREND FINALLY OUR FRIEND?
This morning’s news that new claims for jobless benefits fell last week is the best news yet for thinking that the recession has peaked. It’s still too soon to break out the champagne, as we’ll explain. But for the moment, a collective sigh of relief is in order. Maybe.
As the chart below shows, new filings for jobless benefits tumbled by 53,000—the biggest weekly drop since December. More important is the trend. Since reaching a seasonally adjusted high for this cycle of 674,000 for the week through March 28, new jobless claims have fallen in each of the subsequent two weeks, lowering the total to 610,000 last week. That’s still an unmitigated sign of recession, but the recent fall also begs the question: Does the downshift have legs?
This is a critical question because, as we’ve written, initial jobless claims are a valuable forward-looking indicator for estimating when recessions bottom out. In our March 6 piece, we looked at the historical record and found that initial jobless claims peaked concurrently with, or sometimes ahead of the formal end of recessions since the late-1960s. That’s valuable information since identifying the end of the business cycle downturn is much easier after it’s obvious to the crowd. The National Bureau of Economic Research, which officially dates the start and end dates of recessions, makes its proclamations long after the fact. Meanwhile, most of the popular metrics for gauging the state of the economic cycle, such as the unemployment rate, are lagging indicators and so they’re among the last to reveal when the recession has turned, much less ended.
DEFLATION: NOT QUITE DEAD (AGAIN)
The case for remaining cautious on the economic recovery grew a bit stronger today with the updates for wholesale prices and retail sales. Both registered declines, suggesting that strategic-minded investors should stay opportunistically cautious.
The economic data in recent months offered reason to think that the deflationary risk might be fading. That hope hasn’t faded entirely, but it’s a tad weaker today than it was yesterday, in light of news that retail sales slipped 1.1% last month and wholesale prices retreated by 1.2% in March.
THE NEXT HURDLE
It’s hard to dismiss the ongoing news about China’s anxiety over its massive holdings of American debt. What’s worrisome for China is ultimately a concern for the U.S., with fallout that may come sooner than we think.
“We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried,” Chinese prime minister, Wen Jiabao, said last month. It was a rare public admission of apprehension by a high-ranking Chinese official on the delicate and increasingly precarious lender-borrower relationship that describes the U.S. and China.
Today comes word that China’s purchases of U.S. bonds slowed in the first two months of this year, according to new data from China’s central bank, The New York Times reports. “Chinese reserves fell a record $32.6 billion in January and $1.4 billion more in February before rising $41.7 billion in March, according to figures released by the People’s Bank over the weekend,” the Times notes. The trend may now be reversing, although the notion that a pivotal point in the U.S.-China financial relationship may be near remains intact.
THE MORE THINGS CHANGE…
Banking crises are old hat in capitalism, and much of what ails us these days is first and foremost a banking crisis. The question is whether that matters in diagnosing the cause, and the apparent solution for the recession du jour? It does…maybe.
Economic contractions brought on by a banking crisis must be distinguished from downturns born of what some might call the growth cycle’s old age. In the latter, the central bank takes away the proverbial punch bowl in an effort to reduce the risk of inflation. An extended period of economic growth tends to elevate inflationary pressures, which compels central bankers to raise interest rates. Elevating the price of money, in turn, raises the risk of recession.
Of the two basic drivers of recession, the former describes the source of our current predicament. The missteps by the financial sector, in other words, planted the seeds of this downturn. Recessions born of banking crises aren’t unprecedented, but they’re relatively rare. Good thing, too, since the blowback is particularly difficult to solve, at least in a timely and obvious manner.
RISK: THE SOLUTION AND THE PROBLEM, ALWAYS AND FOREVER
Risk never gives investors a break. It’s constantly baiting us, dispensing false signals and generally throwing landmines on the path that appears as a smooth trek to easy gains.
Consider that the past 20 years have been particularly fruitful in financial economics for identifying sources of partial predictability in certain data series. A few examples include dividend yield and other fundamental valuation measures that have shown robust results for estimating the equity premiums for medium- to long-term horizons. The shape of the yield curve and the spread between interest rates on corporate and Treasury bonds have also shown encouraging results as predictors.
In fact, there are a number of factors that are worth monitoring on a regular basis for estimating the price of risk in the major asset classes. No surprise, then, that watching dividend yield, the term structure of interest rates and a host of other metrics, and inferring risk premia and asset allocation from the analysis informs much of our work in The Beta Investment Report. The danger is thinking that the investment challenge has been solved.