The scent of recession may be in the air, but it’s not yet creating a stink in jobless claims.
New filings for jobless benefits fell last week to 317,000, the lowest in a month, the Labor Department reported. As you can see from the chart below, the trend doesn’t look particularly ominous. In fact, it looks quite middling by the standard of recent history.
The future may bring darker trends, but for the moment the status quo prevails. In fact, it’s not too hard to find an economist who’ll tell you that initial jobless claims running consistently below ~330,000 a week suggests a bubbling U.S. economy. And while we’re looking at trends, let’s not forget that initial claims have now fallen for three weeks running.
“It’s still consistent with a moderate expansion of the labor base.” Richard DeKaser, chief economist for National City Corp. in Cleveland, told Reuters today.
But let’s not get too excited. Jobless claims numbers not necessarily dispense timely warnings far in advance. Going back to the last time Wall Street and the economy ran into trouble, it’s worth remembering that initial jobless claims stayed calm long after the stock market bubble burst in March 2000. It wasn’t until December of that year and into the first quarter of 2001 that jobless claims reflected the dangers that had been brewing for some time.
Author Archives: James Picerno
ARGUING WITH THE CROWD
On September 17, the benchmark 10-year Treasury yield ended the trading session at 4.47%, or nearly 80 basis points below the target Fed funds rate, which was 5.25% at the time. The yield curve, in short, was inverted and by more than a little. The next day, the Fed cut rates by 50 basis points, which was followed by another 25 basis point cut at the end of October.
Today, the Fed funds rate is 4.50% and the yield on the 10-year Treasury yield is 4.36%, as per last night’s close. The yield curve is still inverted, albeit by a smaller margin compared with September 17.
Meanwhile, the market for Fed funds futures seems to be inclined to think that another rate cut is coming. Perhaps, although the easy cutting is now behind us.
Lower interest rates invariably come as a package deal, with positive and negative effects. Enhanced liquidity has the power to boost spending, at least in the short term. But lower rates come at a cost elsewhere. Those costs have been minimized and largely overlooked in past years. But that was a function of the moment.
RANTING ABOUT RISK (AGAIN)
The strategies that increase the odds of achieving investment success too often get a bum rap. Drowned out by the advice du jour, financial prudence is forever getting trampled in the latest news cycle as more enticing notions grab the crowd’s attention. Buy this, sell that. Oh, look, XYZ Corp. posted an unexpected rise in earnings last quarter. But, wait, look over there: same store sales are down and Uncle Billy’s Medical Supply Inc.
So it goes in the 21st century, which is awash in investment advice, analysis and outright guessing. Some of its ok, most of it isn’t, and only a small minority of it’s worthy of being enshrined as enduring principles. Only today your editor stumbled across a column of questionable value published by one of the major outlets in the so-called new media. The basic message: mutual funds are for those who don’t know any better. Far better, the column recommended, that investors pick a handful of stocks and forget about it. Not just any stocks, of course, but those that have durable brands and businesses that will stand the test of time and that are selling on the cheap. In short, you don’t need a mutual fund.
The rationale given is that Warren Buffett doesn’t use mutual funds and so neither should you. In fact, the author quoted Buffett directly, lest there be any doubt of the true road to investment success: “Diversification is a protection against ignorance.”
Of course, investing isn’t quite so simple. For starters, Buffett has also gone on the record as saying that index funds are a pretty good investment after all. As the Oracle of Omaha advised earlier this year, “A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money.”
The strategies that increase the odds of achieving investment success too often get a bum rap. Drowned out by the advice du jour, financial prudence is forever getting trampled in the latest news cycle as more enticing notions grab the crowd’s attention. Buy this, sell that. Oh, look, ABC Corp. posted an unexpected rise in earnings last quarter. But, wait, look over there: same store sales are down.
So it goes in the 21st century, which is awash in investment advice, analysis and outright guessing. Some of its ok, most of it isn’t, and only a small minority of it’s worthy of being enshrined as enduring principles. Only today your editor stumbled across a column of questionable value published by one of the major outlets in the so-called new media. The basic message: mutual funds are for those who don’t know any better. Far better, the column recommended, that investors pick a handful of stocks and forget about it. Not just any stocks, of course, but those that have durable brands and businesses that will stand the test of time and that are selling on the cheap. In short, you don’t need a mutual fund.
The rationale given is that Warren Buffett doesn’t use mutual funds and so neither should you. In fact, the author quoted Buffett directly, lest there be any doubt of the true road to investment success: “Diversification is a protection against ignorance.”
Of course, investing isn’t quite so simple. For starters, Buffett has also gone on the record as saying that index funds are a pretty good investment after all. As the Oracle of Omaha advised earlier this year, “A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money.”
A NEW BULL MARKET IN VOLATILITY, A.K.A. OPPORTUNITY?
Judging by this morning’s update of the ISM services industry index for October, the economy doesn’t look all that bad. But there are an infinite number of ways to judge the economic outlook and it appears that for the moment more investors are inclined to judge the glass as half empty rather than half full.
The stock market certainly found no reason to cheer in the wake of today’s ISM news. Yes, services now dominate the U.S. economy compared with the diminishing role of manufacturing. In fact, the October rise in the ISM services index exceeded expectations as upward momentum in the sector took root last month, as the chart below shows. “The [ISM services index] numbers are pretty good,” David Sloan, an economist at 4Cast Ltd., told Reuters. “It suggests the service sector is growing at a decent pace so the economy is not in too much trouble overall, at least for the moment, despite the weakness in housing.”
As such, one might think that a favorable reading for the index would dispense a bit of optimism. Not today, at least not as we write at roughly halfway through Monday’s trading in New York. U.S. stocks opened sharply lower this morning, although the losses were pared by noon.
A TIMELY GIFT FROM THE EMPLOYMENT GODS
Here we go again? Maybe. Another economic release, another opportunity to rethink yesterday’s conventional wisdom.
This morning’s news that employment growth was a lot more bubbly last month than economists expected. The consensus forecast called for a rise in nonfarm payrolls of just 80,000 for October, according to TheStreet.com. That would have been one of the smallest gains in recent years.
As it turned out, the gloom was misplaced: payrolls rose by 166,000 last month, the highest pace since May, as our chart below shows. Meanwhile, the unemployment rate remained unchanged at 4.7%. Given yesterday’s hefty drop in the stock market, today’s news at least offers a temporary reprieve from an otherwise gloomy week of news.
The rebound in job growth in October marks a striking reversal of the sluggish rate of expansion in previous months. From June through September, monthly employment growth was under 100,000, the longest stretch of subpar increases in recent memory.
THE PARTY ROLLS ON
October paid off once again for the optimists. Red ink was nowhere to be found among the major asset classes, as our table below shows. Even the battered REIT market posted a handsome gain last month.
What’s extraordinary here is the persistence of bull markets in everything. In fact, it’s downright amazing. On a 1-year basis, everything’s up, and the same can be said when reviewing longer term records as well. The lone case of loss shows up only in REITs in the year-to-date column. But that’s hardly a calamity, given the potent rise in the asset class for the better part of the past seven-plus years.
Meanwhile, the Federal Reserve is doing what it can to keep the bulls happy. Yesterday’s 1/4 point cut in Fed funds received a warm welcome in the stock market. The S&P 500 rallied 1.2% yesterday, reaffirming once again that the equity crowd loves liquidity.
The sentiment’s a bit more complicated in the bond market. The initial reaction to the Fed’s cut among the fixed-income set was to sell first and ask questions later. As a result, the yield on the benchmark 10-year Treasury popped by the close of yesterday’s trading, rising to 4.48%, the highest in nearly two weeks. But no one should confuse the 10-year’s yield as excessive. A 4.48% rate is roughly the lowest in the past two years.
HALLOWEEN RALLY
In the wake of today’s 25-basis-point cut in interest rates by the Federal Reserve, the not-so-subtle message is that the economy will weaken. But the cut comes just hours after the Bureau of Labor Statistics told us that economic growth was higher than expected in the third quarter at a respectable 3.9%. Not only is that slightly faster than the annualized real 3.8% growth in the second quarter, that’s the fastest pace since Q1 2006.
Of course, no one expects that the 3.9% is a prelude to something better, or even the standard for the foreseeable future. The Fed, to cite one source, expects the economy to slow. If a downshift is coming, diminished consumer spending will be the reason, probably due to the ongoing fallout from housing.
But there was no sign of that in today’s GDP report. In fact, personal consumption expenditures, which are GDP’s driving force, jumped 3.0% in Q3. What’s more, consumer purchases of durable goods rose at an even faster pace, ascending 4.4%–well above the economy’s overall rate of expansion.
BACK FROM THE GRAVE
Actually, beta never died, as many have proclaimed over the years. In fact, beta’s never been more influential.
As yours truly detailed in the November issue of Wealth Manager, beta’s very much alive and kicking. What’s more, beta’s at the heart of a number of cutting-edge of a number of portfolio applications in the 21st century.
Beta, of course, is a risk measure that’s pivotal in the Capital Asset Pricing Model, which lays much of the foundation for indexing. Although CAPM is more than 40 years old, this durable theory continues to inspire innovation in portfolio management.
CAPM isn’t perfect, of course. The world is a complicated place, and no one theory can capture all the nuances that collectively define the global capital markets. Yet CAPM does a pretty good job of delivering the goods when its lessons are translated into indexing. Meanwhile, creative minds in finance keep trying to improve CAPM as a tool for the real world. Witness the ongoing love affair with ETFs, which speak volumes about the market’s enduring embrace of beta. But ETFs are just the tip of the iceberg in the evolving story that is beta.
For a closer look at why you should care, read on…
THE TROUBLE WITH SUCCESS
It’s an ancient problem, although as “problems” go it’s one of the better ones to have since it implies that you have money to manage. But it’s a problem nonetheless, and it becomes increasingly obvious as an investment portfolio grows.
Reviewing the nest egg of yours truly over the weekend revived the challenge anew of how to keep the growth relatively high in relative terms without assuming an imprudent amount of risk. Like many investors, your editor has done quite well since 2002. So it goes when bull markets bloom like weeds. Buy now what? The portfolio’s bigger, and so is the hurdle to keep up the momentum.
It should come as no shock to learn that growing a fund of, say, $100,000 at 10% per annum is far easier than keeping a $1 million fund rising at the same rate. Yes, it can be done, but it requires increasing amount of skill, luck or both.
The problem is further compounded at this juncture in the investment/economic cycle, or so we believe. There are more than a few risks swirling about the capital markets these days. The fact that most markets are at or near all-time highs suggests one or two things to the jaded mind producing the text before you.
The point being that reaching for the extra return at this point may be dangerous, perhaps more so than usual. Yet the incentive for reaching today is probably higher than it’s been in some time. Given the capacity for bull markets to lift all boats and raise expectations, most investors have portfolios that are materially larger compared to, say, five years previous. Some of that can be attributed to skill, but most of the growth was no doubt spawned by the genius of a bull market.
VOLATILITY & CORRELATION UPDATE
The last few months have been a roller coaster if you look at the markets through the prism of return. But what’s the view if we survey the investment landscape via volatility and correlation? Has the world really changed all that much by these metrics?
Let’s start with volatility, which we define as the standard deviation of monthly total returns for the trailing 36 months. Graphing that measure of risk on a rolling basis for each of the major asset classes over time reveals that the great decline in volatility in recent years remains intact, as our chart below illustrates.
Yes, volatility has in fact spiked if we calculate volatility on a daily or weekly basis. But the spikes have yet to show up in any meaningful way on longer-term measures of volatility, as you can see in the chart above. That doesn’t mean that long run vols will stay low, although they might. But for the moment, the jury’s still out on whether market volatilities generally have entered a new era, which is to say a higher plateau.
Meanwhile, what’s the trend been for diversification of late? We’re defining diversification here as correlation between monthly returns for the trailing 36 months. Looking how several asset classes stack up on that measure on a rolling basis against U.S. equities (Russell 3000), it’s clear from our second chart below that recent history is a mixed bag (1.0 is perfect positive correlation; 0.0 is no correlation; less than zero is negative correlation).
Bonds (LB Aggregate) and commodities (DJ-AIG) are still potent diversification tools relative to U.S. stocks, but less so these days than in the past. The trend of rising correlation is especially strong between REITs and U.S. stocks. Meanwhile, foreign stocks (EAFE and MSCI Emerging Markets) continue to provide slightly more diversification compared to domestic equities.
The good news is that risk-adjusted returns are enhanced by adding asset classes with less than perfect correlation to a portfolio’s existing holdings. By that standard, owning a broad array of the major asset classes still makes sense. Alas, diversification isn’t quite what it used to be. On the other hand, beggars can’t be choosy.