2013 Outlook

After a quick start to 2013 for economic data and events in recent week, the coming weeks are relatively quiet. The key domestic economic report due out this week is likely to be the latest weekly reading on initial claims, as markets focus on the unofficial start of the fourth quarter earnings reporting season. Five Federal Open Market Committee (FOMC) members are scheduled to speak this week, and almost all of them have spoken out against quantitative easing. Overseas, a full slate of Chinese economic data for December 2012 are due out, as well as key central bank meetings in the Eurozone, the United Kingdom, and South Korea. In addition, both Spain and Italy will auction debt.

On balance, last week’s U.S. economic data on manufacturing, employment, vehicle sales, consumer sentiment, and the service sector for December 2012 exceeded expectations, and kept real gross domestic product (GDP) on track to post a gain of between 1.5% and 2.0% for the fourth quarter of 2012. Any increase in GDP in the fourth quarter of 2012 would mark the fourteenth consecutive quarter of economic growth since the end of the Great Recession in the second quarter of 2009.

Looking ahead into the current quarter (first quarter of 2013), growth may get a boost from a rebound from Superstorm Sandy, but the payroll tax increase that occurred as a result of the fiscal cliff deal signed into law by President Obama will put a dent into consumers’ disposable income in the
quarter, and leave real GDP growth around 2.0%. Looking ahead, failure failure to address the debt ceiling (and lingering sequestration issue) may lead to a recession in early 2013, while a quick resolution to the looming debt ceiling debate along with a “Grand Bargain” to address the nation’s longer term fiscal issues could lift real GDP growth into the 3.0% range for the year.

On balance, the first quarter, and indeed 2013 in general, is shaping up as follows: On the positive side:

• Rebuilding of infrastructure and housing stock damaged by Sandy;
• A continuation of recovery in the housing market;
• A reacceleration in growth in China and emerging markets, which will help boost exports; and
• A rebound in business spending after fiscal cliff and election-related uncertainty hurt business capital spending in the fourth quarter of 2012; should help offset the following negatives;
• Tepid consumer spending;
• Weak federal and state and local government spending; and
• Muted contribution from net exports with Europe still in recession.

Overall, from an economic standpoint, 2013 may look and feel a lot like 2012.

The LIBOR scandal: What it is and why you should care

The London Interbank Offer Rate, commonly known as LIBOR, was manipulated by Barclays and that should make you angry. Most people have no idea what LIBOR is, but it has a major impact on the lives of most Americans. LIBOR is the average interest rate that large banks in London charge to one another to borrow money. The rate charged between banks in London turns out to be the basis for the interest rates on more than $350 trillion in loans and derivative contracts. And, the rate impacts the interest rate we pay on everything from adjustable rate home loans and auto loans to credit cards and almost all other kinds of credit.

Eighteen large, London-based banks daily report their cost of borrowing to the British Bankers Association; those values are averaged and then LIBOR is published. If the rate the banks report is high, it means either (1) that interest rates are high or (2) that lending money to the bank is perceived as risky because of its potential for default. Recently, Barclays admitted to lying about the rate it was being charged to borrow money, and the bank paid a $453 million fine to U.S. and British government authorities for doing so. At first Barclays claimed that it lied about manipulating LIBOR because the bank did not want to admit that other banks were afraid to lend Barclays money. But now there is evidence that potentially many banks were lying about their actual borrowing costs so that they could profit on derivative trades where payoffs are dependent on the level of LIBOR. That the very banks that set LIBOR also get to trade derivatives tied to the index, well, that is what we call “letting the fox guard the hen house.”

You should be angry because it appears that Barclays is not alone in manipulating LIBOR; in fact, the practice was a bit of an open secret among many banks. Sometimes these manipulations saved you money by lowering your interest rates. Longer term, these manipulations make our credit markets less efficient and result in higher overall rates for everyone. The one positive note is that the U.S. Department of the Treasury is taking the lead to clean up the way this important interest rate measure is calculated. It’s nice to see the United States taking the lead, at least in this instance, in making sure that the public is treated fairly.

The Fiscal Cliff

Have you read about or heard about the “fiscal cliff” the U.S. is facing? In 2011 an agreement was reached in Congress to raise the amount of debt the government could issue so that the U.S. wouldn’t default on its obligations. There was a catch however, if Congress couldn’t come up with offsetting cuts by the beginning of 2013, $641 billion in spending cuts and tax hikes would automatically go into effect.  The impact of these cuts, which are equal to almost 5% of the US Gross Domestic Product (GDP), could be devastating, sending the U.S. back into recession. 

At the time these cuts were set in place, 2013 seemed like a long way away and the cuts that were laid out were so draconian, that an agreement seemed all but certain. Now 2013 is approaching, and a solution has not yet been proposed; the impending drastic spending cuts and tax hikes are the fiscal cliff you will be hearing more about in the media in the coming weeks and months.

Wealth Enhancement Group isn’t alone in worrying about the impacts of this fiscal cliff. Chairman Bernanke expressed his concern in a statement during a June meeting before the Joint Economic Committee of the U.S. Congress and said that if Congress failed to address the fiscal cliff, it would “pose a significant threat to the recovery.”  Former President Bill Clinton stated that we need to “find some way to avoid the fiscal cliff, to avoid doing anything that would contract the economy now” on a CNBC interview.  And, Treasury Secretary Larry Summers added that the top priority should be not taking “gasoline out of the tank at the end of this year.”  Federal Reserve Bank of Dallas President Richard Fisher added fuel to the fire, sharing his view that Congress has had “reckless fiscal policy.”  Making matters even more complicated, political observers don’t expect any action before the presidential election in November, which provides very limited time to actually address these important budget issues. 

So with these spending cuts and tax hikes our politicians have put a trigger in place that could lead to slower growth and even recession. At Wealth Enhancement Group, we have enough faith in the political system of the U.S. that we believe a deal will be reached that will avoid “yanking the rug out” from under what is already a fragile economy.

In the end, politicians are usually rational and if they don’t find a solution, they’ll be responsible for what may clearly be bad decisions and one that won’t help them win votes.  The best-case scenario for the economy and markets would be a grand bargain that maintains short-term spending, but reduces the country’s long-term, unfunded liabilities. While a grand bargain may still be out of reach, we believe that smaller compromises are more likely than not.  So while we’re concerned about the fiscal cliff, we ultimately think that the worst case scenario is unlikely.

Wealth Enhancement Group

Last week’s data, next year’s economy

The numbers are in. Retail sales are up two months running. Black Friday online sales were up 26% over last year. Industrial production is up. Permits for new single-family homes are at their highest point in a year and a half. Inflation is down, and the number of people applying for jobless benefits is near the lowest point since April. The economy may not be dancing a jig, but it has risen from its deathbed and is up and walking around. Few, if any, economists are predicting a double-dip recession; their consensus estimate puts fourth quarter GDP growth at 2.5%

So why was the S&P 500, the broad measure of market performance, down 4.8% for the week after being down 3.5% the previous week?

One reason is questions about the long-term sustainability of the recovery. Roughly 70% of GDP is consumer spending. And consumer spending is dependent on people having jobs. The economy added 80,000 jobs in October, down from 158,000 in September and 104,000 in August. It needs to do much better, at least 200,000 per month in order to reduce the current 9.0% unemployment rate. The growth in retail sales can’t continue unless hiring increases and wages rise. Neither of those things is happening at a self-sustaining rate.

The other reason is Europe, which promises to be a source of financial instability for the foreseeable future, and a drag on the confidence of American markets and businesses.　

In the short term the cascading series of potential failures, Greece to Italy to Spain to France, has financial markets unsettled; banks on both sides of the Atlantic own trillions in European sovereign debt.

In the medium term Europe faces the likelihood of recession, in large part due to the failed policy of budget cutting to trim deficits instead of spending to create job growth. That means decreased demand for American goods from our biggest trading partner and fewer American jobs created.

The net: uncertainty continues to reign on Wall Street, on Main Street, and across Europe, so it is important to keep your portfolio diversified. We’re watching the markets and keeping our options open to make prudent investment shifts as necessary.

James Copenhaver, Director of Investment Management

Current Economic State: “Shaky Stability”

A respected economist recently referred to our current economic state as “shaky stability.” It isn’t often that an oxymoron is more than an amusing description, but this one is particularly apt.

Unemployment is stuck at 9% and has been since spring. Job growth is stuck at an average of 72,000 per month and has been since spring also. The economy is creeping along just fast enough to employ new workers entering the labor market, but not fast enough to budge unemployment. We’re not in a recession, but we haven’t recovered from the last one either.

That’s the stability part, and it isn’t a good stability.

The economist didn’t talk much about the shaky part, but it’s pretty clear. The U.S. political process is shaky, with the two parties unable to agree on measures that would lead to economic recovery and growth. Europe is shaky, with the countries of the Euro Zone unable to agree on measures that would save their banks from the cascading failures resulting from a Greek default. Even China, the engine of global growth, is shaking a little as its furious rate of modernization inevitably slows.

The Greek default situation right now is the event most likely to shake the stability. A solution to the Greek debt crisis, or measures that would spur U.S. job growth, could inspire business and consumer confidence that would lead to long-term, self-sustaining economic growth.

The future is uncertain. Stay tuned.

James Copenhaver, Director of Investment Management

 

FOOTNOTE:

Economist Jared Bernstein:  http://jaredbernsteinblog.com/jobs-report-second-impression-shaky-stability/

President Obama and Fed Chairman Bernanke Give Speeches on the Economy

On Thursday, September 8, both President Obama and Fed Chairman Bernanke gave speeches on the economy.

Most of what Bernanke said, he’s said before. After all, American business is sitting on huge amounts of cash that it isn’t investing. It isn’t borrowing to grow either. The Fed has done everything non-inflationary that it can to send interest rates to historic lows to encourage spending. Spending isn’t happening, so what more can the Fed chairman say?

Something interesting.

Bernanke said he thought Americans were overly pessimistic about the economy. Given the numbers on wages, debt, loan rates and housing prices, consumers should be spending more, creating demand and growing the economy. Instead, they’re doing exactly what business is doing: not spending. The cycle of pessimism feeds on itself, stifling demand, which in turn stifles growth.

Perhaps the main cause of that pessimism is unemployment and the lack of job growth. That’s where President Obama’s speech comes in. The American Jobs Act that he proposed has $240 billion in employee payroll tax cuts through 2012, tax cuts for small businesses, and a small business tax holiday for hiring new employees. It has $140 billion for modernizing schools and for repairing roads and bridges. It has $35 billion for saving teacher jobs and hiring new teachers.

Moody’s Analytics’ chief economist Mark Zandi says the president’s jobs package would likely create 1.9 million payroll jobs, grow the economy by 2%, and cut unemployment by 1%.

Is it big enough? Maybe. It needs to go beyond staving off another recession to jumpstart self-sustaining growth for the economy. Is it apportioned right? Maybe. Direct spending is historically more effective than tax cuts, but tax cuts work.

And can it be passed by the most bitterly divided Congress since the 1850s? We’ll see.

James Copenhaver, Director of Investments

A Debt like No Other

If you have incurred inefficient debt, one method of eliminating it is to transfer the debt to your home equity. Many people are reluctant to use their home equity to consolidate other debt. This reluctance really stems from a mind-set that is behind the times. Certainly, 30 years ago, if people refinanced their home or took out a second mortgage, you can be sure the neighbors were talking behind their backs about their financial woes. But using your home’s equity is economically wise. It provides low interest rates, a tax deduction, and an extended amortization.

However, even this form of debt should not be used recklessly. Defaulting on a mortgage of any kind has greater consequences than defaulting on consumer loans. Mortgage loans are secured by your home, which means that if you can’t make payments, you will lose your home. Consumer credit lenders cannot take such drastic remedies.

Avoid all other kinds of debt, including the high-risk debt of stock margin purchases and stock and commodity options. Leave those investments to the professional gamblers. Otherwise, buy only what you can pay for with cash.

Proposed Reforms (Part 2)

Consumer Lending Rules – Last Wednesday, the House passed a bill by a wide margin to move up the start date to limit banks’ rate increases on existing credit-card balances. The Financial sector swooned by a few percentage points as soon as the bill passed. There will be increased scrutiny of many of the lines of lending from credit cards to student loans.

Credit Default Swaps – Right now, many derivative agreements are private one-on-one contracts in what is called the over-the-counter market. These opaque transactions are outside the view of the public or regulators and are dependent upon the parties remaining solvent. If one party becomes insolvent, it may take the other with it. This lack of transparency in volume, size, and counterparties proved disastrous in the financial crisis.

In the bailout of American International Group, tens of billions of dollars went to settle these contracts to avoid a domino effect. The reform proposals require that many derivatives be traded on public exchanges providing transparency on the volume and size of the market and providing each party an exchange whose creditworthiness would be backed by the entire industry. Forcing these contracts to be traded on an exchange may limit the risk they pose to the financial system.

Shopping for a Lender (Part 2)

It is just as important to look for a lender with a reputation for integrity and service. You will be sharing all of your most private financial information with your loan company. Signing for a loan is a big commitment, so make sure that you feel comfortable with your lender. Here are some important items to consider when shopping for a mortgage lender:

Rate Commitment
Many lenders quote an interest rate at the time of application. However, if market interest rates should go up or down during the period before you close on your loan, you need to find out what interest rate you will ultimately be charged. It is also important to know how long the lender will commit to this rate.

Loan Servicing
After your loan is closed, you will be dealing with a loan servicing company. The loan servicing company will accept your payment every month and handle any questions you may have concerning your mortgage balance. Many lenders service their own loans while many others sell their servicing to outside firms. You should know upfront that the lender you choose works with reputable loan servicing companies.

Considering the cost involved, your final choice of a lender should be one who offers you a good deal financially. However, keep in mind that you will be dealing with your lender for many years and it is always easier to deal with people you like and trust.

Shopping for a Lender (Part 1)

When shopping for a mortgage lender, you should make price comparisons, but interest rates alone should not be the determining factor in choosing a lender. Here are some important items to consider when shopping for a mortgage lender:

Fees
Mortgage lenders charge fees for a variety of things such as filing an application, appraisal, credit reports, etc. Be sure to know upfront what the lender charges are so that there are no surprises at closing. Lenders are required to state interest as an annual percentage rate (APR). This rate takes into account the loan origination fees. When comparing interest rates among various lenders, be sure to use the APR as your measure.

Processing Time
What is the average length of time for a mortgage loan to be processed? This is an important question to ask if you need to move into a home quickly.