Does money matter? The answer depends on who’s talking. Suffice to say, however, Milton Friedman’s dictum that inflation is always and everywhere a monetary phenomenon is now debatable in the academic community as well as in the board rooms of central banks around the world.
Consensus on the strategic answer for managing inflation appears to be fading. Michael Sesit at Bloomberg News has a nice essay today on some of the stress points that harass the subject of inflation theory these days.
Category Archives: Uncategorized
TALKING ABOUT OIL
Where’s the price of oil headed? Higher, says Matt Simmons, CEO of Simmons & Co. International, a Houston energy-focused investment bank. Of course, Simmons has been saying that for years. In fact, his bullish view on crude predates the great energy bull market of the 21st century.
The surge in oil’s price doesn’t surprise Simmons because the fundamentals of supply and demand have been sending a clear signal about the future since the late-1990s, he says. For example, the discovery of large oil fields on a global basis has trailed off over the years, his research advises. Meanwhile, global demand keeps rising. And with China, India and other developing economies looking for more oil than ever before, the prospect of keeping supply and demand balanced looks more challenging by the day.
YIELD ANALYSIS
Dividend yields don’t tell you everything, but they tell you a lot. Sometimes.
A fair number of studies over the years find that the correlation between yield and subsequent return over the next five years and beyond is strong enough to convince fair-minded investors to watch those yields for clues about what’s coming. In other words, higher yields have a tendency to lead to higher returns, while lower yields imply lower returns.
No, it’s not absolute. Nothing ever is in finance. That caveat aside, favoring markets, and points in time when yields are relatively higher has a tendency to improve the odds of capturing higher total returns in the years ahead. In fact, this is an old idea, captured in Ben Graham’s famous counsel that the market is a voting machine in the short run and a weighing machine in the long run. By that he meant that speculators rule now, tomorrow, next week and even next year when it comes to setting prices. But over longer periods, certainly five years or more, valuation dictates price. And dividend yield has proven to be an especially robust signal of expected returns.
With that in mind, we present two charts, each telling different stories. The first chart below graphs the dividend yield history for the world’s developed markets. Although the absolute levels vary, the trend of late has been consistent across regions: yields are up. That’s a function of the fact that prices have fallen relative to levels of a year ago.
click to enlarge
WILL MAY LOOK LIKE APRIL?
It’s hardly great news, but the fact that job destruction was a bit less destructive last month will inspire the optimists that the recovery has begun.
Nonfarm payrolls shrunk by a relatively modest 20,000 last month, or roughly a quarter of the monthly losses that have been posted in each of the previous three months of this year. The April reprieve, if we can call it that, certainly made a graphical impression. As our chart below shows, last month’s softening in job losses ended a five-month stretch of decelerating conditions for minting new employment opportunities. By that we mean that for the first time since last October, the trend last month didn’t worsen compared to the previous month. And while we’re pointing out reasons to be cheerful, let’s note that the jobless rate ticked down to 5.0% in April, slightly better than the 5.1% for March.
But let’s not get carried away, at least not yet. Let’s not forget that goods-producing employment is still getting hammered even as the broader employment picture offers reason for hope. Meantime, Wall Street is eager to see light at the end of this tunnel, as yesterday’s stock market surge suggests. Yet another rate cut by the Fed earlier in the week helped get the bulls’ hearts racing, as did an improvement in the dollar in forex markets. And as we noted yesterday, April generally was a good month for most asset classes.
So, what’s the problem? As always, there’s no shortage of things to worry about. But no one should underestimate the stock market’s capacity for climbing this year’s wall of worry. Mr. Market is always looking forward while many of us are overly focused on the past. Such is the limitations of being stuck with wetware as the primary tool in the business of asset management.
APRIL SHOWERS BROUGHT PERFORMANCE FLOWERS
The major asset classes had their best performance month in April since last October. Only TIPS and foreign developed market bonds suffered red ink last month, as our table below shows. On balance, April was the strongest monthly tally since the perfection of October 2007, when everything was in the black.
April fell short of the October standard, but not by much. Meanwhile, the leading performers were anything but subtle last month. Indeed, April’s big winner was emerging market equities, which soared more than 9%. That’s about as high a monthly rise as this corner of equities has ever posted.
In a strong second-place showing: REITs, up 6.4%, which is another performance that’s rarely topped in any one month, based on the historical record.
Meanwhile, stocks across the board were up, and so were junk bonds and commodities. Let’s just say that April was a success for investors with diversified portfolios. Unless you were loaded to the gills in inflation-indexed Treasuries and/or sovereign bonds issued by the major foreign governments, you almost certainly saw your portfolio’s value rise last month.
JOE TURNS DEFENSIVE
The economy managed to grow slightly in this year’s first quarter, the government reported today. GDP rose by an annualized 0.6% in this year’s first three months, matching the growth rate in Q4 2007. Given all the recession anxiety of late, that’s a victory of sorts. But this is no time for celebrating. As a closer reading of today’s GDP report shows, consumers are turning defensive in their spending habits in a big way.
Personal consumption expenditures (PCE)–which represent about 72% of total GDP– rose by a meager 1.0% (seasonally adjusted annual rate) in the first quarter–down from 2.3% in Q4 2007. That’s the lowest pace since Q2 2001, which also witnessed a 1.0% expansion. The reason for the current slowdown: two of PCE’s three major components posted declines in the first quarter. Spending on durable goods was particularly hard hit, dropping by a hefty 6.1%–the first case of red ink here since 2005. Nondurable goods also slipped in Q1, falling 1.3%. This marks only the fourth instance in the past 15 years that nondurable goods spending contracted in a quarterly reading.
The lone source of consumer spending salvation came via services expenditures; the only member of the three broad gauges that define consumer spending that posted a gain in Q1. Fortunately, services spending posted a healthy 3.4% jump. But that only reminds that consumer spending overall would be shrinking if it wasn’t for the resilience in services.
Nonetheless, no one should misunderstand what’s unfolding: Joe Sixpack’s sentiment to buy, buy, buy has taken a hefty blow, at least for the moment. And no wonder: prices are soaring for basic staples, i.e., energy and food. Meanwhile, the family home is worth quite a bit less and Joe’s investment portfolio probably suffers a similar discounting. Logic suggests that saving more and spending less is eminently reasonable at this juncture. The only question now: How long will the newly defensive sentiment last?
Clearly, it’s premature to say that the worst of the economy’s downshifting is past. Anecdotal evidence for the second quarter, which is barely a month old, suggests that the correcting process is still underway. Perhaps May and June will deliver better news, perhaps not. But based on the numbers presented in today’s GDP update, combined with an objective survey of finance and economic conditions in the month of April, there’s still a case for staying cautious and defensive in one’s investment strategy. The proverbial “other shoe,” it seems, is in the process of dropping as we write.
THE MEANING OF “REFOCUS”
Perhaps it signifies nothing, but the timing is suspicious.
Last December, the Treasury Department announced that it was sharply reducing the annual limit on investments in the inflation-indexed series of U.S. Savings Bonds, a.k.a., I-Bonds, to $5,000 a year as of January 1, 2008–down from $30,000 a year previously. (The $5,000/yr limit also applies to conventional Savings Bonds as of January 1.)
No big deal in the grand scheme of finance, although we can’t help but notice that the new lower limit comes at a time when inflation-linked portion of payouts for I-Bonds look set to rise, as per the methodology that ties a portion of the bonds’ interest rate to the consumer price index.
The official reason for the reduced investment maximum, as per the Treasury’s press release, was rationalized this way: “The reduction from the $30,000 annual limit in effect for both series since 2003 was made to refocus the savings bond program on its original purpose of making these non-marketable Treasury securities available to individuals with relatively small sums to invest.”
THERE WILL BE INFLATION?
The Federal Reserve’s two-day FOMC confab begins tomorrow and the
Leaning toward the view that this will be the end of the cutting is Peter Berezin, Goldman Sachs’ global economist. “We expect this to be the last cut, but the Fed will be flexible in responding to economic conditions,” Berezin tells AFP. “Obviously if the turmoil resurfaces, they will be apt to cut rates again. But barring that, they would like to stabilize rates.”
Meanwhile, senior financial analyst at Bankrate.com Greg McBride tells AP: “We are entering the stage where it is time for the Fed to wind down and move to the sidelines. A quarter-point reduction is a nice segue to that transition. Short-term interest rates could stay low longer than many currently expect.”
Judging by long-dated futures contracts, Mr. Market’s calling for another 25-basis-point cut on Wednesday. The Dec ’08 contract, for instance, currently prices Fed funds at roughly 2.0%. If the Fed cuts by a quarter point, 2.0% Fed funds at the end of the year would represent the longest stretch of interest rate stability for this series since Bernanke and company kept rates at 5.25% for the 15 months through September 2007.
But let’s not get ahead of ourselves. First, let’s see what the monetary czars will do (and say) this week. While we’re waiting, let’s observe once more that cutting interest rates at this juncture may be politically intelligent; it may even look shrewd as the ongoing economic slowdown/recession gathers momentum. But it’s also risky with inflationary winds blowing. We’ll know if cutting is savvy or something else in a year or so. Meanwhile, it’s every investor for herself, forcing everyone into their own speculative craft to weather the macroeconomic seas as they come. With that in mind, let’s take a dip and consider one blogger’s view of the universe.
ECONOMIC DATA DU JOUR
Today’s update on durable goods orders reinforces the notion that the economy is slowing if not contracting. But then there’s the initial jobless claims news, which reports somewhat better numbers of late. So, what’s the deal?
In search of an answer, let’s start with the raw numbers. Durable goods orders slipped last month by 0.3%–the third month in a row of declines. Looking at the annual pace of durable goods orders shows weakness as well, as our chart below illustrates. Clearly, the trend is down, as it has been for some time on a rolling 12-month basis. Notably, red ink has been showing up with increasing frequency in the annual trend.
click to enlarge
What, then, should we make of new filings for unemployment claims? The Bureau of Labor Statistics reports that since new claims hit a recent peak of 406,000 for the week through March 29, 2008, filings have dropped to 342,000 through last week, as our second chart shows.
click to enlarge
It’s tempting to see the drop in new filings as a sign that the economic ills are now behind us. Nonetheless, we’re skeptical. One reason is that corporate America has been running its payrolls rather lean in recent years compared to previous expansions. Between outsourcing, technology and heavy pressure to run a tight ship, businesses don’t go overboard in swelling its ranks, at least not relative to what passed for average in decades past. As a result, this data series may not surge as much on an absolute basis this time around compared with past cycles.
Meanwhile, weekly jobless claims are a “noisy” bunch, suffering lots of volatility in the short run. Ultimately, the broader trend is the only reliable signal and by that standard it’s clear that jobless filings have been turning up on a relative basis since last fall. Until and if there’s fundamental reasons to think otherwise we continue to expect more of the same.
Based on other economic variables we track, it still looks like the economy’s suffering. Today’s update on new home sales, for instance, reveals the lowest level in 16 years. But recession isn’t our biggest worry, at least not yet. Rather, it’s the outlook for the rebound that makes us anxious. Everyone knows that recessions are painful. Fortunately, salvation comes, eventually. But for a number of reasons that we’ll detail in future posts, the upcycle may not be quite so strong this time. But let’s not get ahead of ourselves. By our reckoning, we’re still grappling with a downturn and on that score there’s still plenty of mystery left, starting with: how long, how deep?
PEAK PERFORMANCE
Has the maximum point of stress in the capital markets passed?
There’s no one measure for answering the question. In fact, there’s no convincing answer short of letting time pass. But for those looking for a bit of perspective in real time, among the worthy gauges to watch in search of clues is the spread in junk bond yields over the 10-year Treasury yield. By that standard, a minor milestone recently passed considering that this spread touched a recent peak of 7.93% last month (based on closing yields on March 17, 2008), as our chart below shows. The question: Will the peak will hold?
click to enlarge
Only time will tell, of course. Meantime, what lessons does recent history offer? For starters, an investor who bought junk bonds as an asset class at the peak, i.e., at the close on March 17 is now sitting on a 4.5% return, based on the price change of iShares iBoxx High Yield ETF (HYG) from that date through last night’s close. So far, that’s middling compared with other asset classes. The S&P 500, for instance, has jumped 7.5% over the same period–as per the Spider ETF (SPY)–while U.S. bonds generally have slipped by around 80 basis points over those weeks, as measured by iShares Lehman Aggregate Bond ETF.
Buying when risk premiums are high, or selling when they’re low, is eminently reasonable and in the long run it may be the closest thing to a free lunch for strategic-minded investors. Accordingly, one might wonder if the 793-basis-point risk spread embedded in junk bonds last month was a buy signal for the long haul.
Perhaps. Looking at spreads going back to 1999, as we did last November, reminds that a near-800-basis-point risk premium looks pretty good based on the knowledge that the spread’s high point over the past 9 years is only modestly higher, at roughly 1,000 basis points, reached for a time in 2002.