Economic Update: The View From 3 Months In

April 24, 2012

Except for those who are still unemployed, 2012 has been a good year so far. The U.S. economy is recovering slowly, and there are many indications it will continue to recover. Markets are up, with the Dow reaching the 13,000 milestone last seen in 2007. Greece hasn’t defaulted. Even unemployment is showing signs of improvement.

The U.S. picture
The consensus prediction is for 2% to 3% economic growth in 2012. That’s better than the 1.7% of 2011, but too slow to quickly cut unemployment from 8.3% to a more acceptable level.

Job creation, nevertheless, is increasing. December, January and February added 244,000 jobs a month, the most since before the Great Recession. Many experts think that productivity growth is maxed out and more hiring is inevitable. Businesses are investing in new equipment after spending the last two years increasing production by working off spare capacity.

Consumers are spending and borrowing again, even for big-ticket items like cars. February auto sales were at the highest since 2008. Housing starts show signs of recovery, spurred by continuing record-low mortgage rates.

So what gives us pause? Oil. Should tensions with Iran turn to war, higher gas prices would dramatically cut consumer spending, and slow the U.S. economic recovery as a whole.

Europe and Asia
Europe appears to have avoided a severe financial crisis, and while its recession is expected to be mild, the United States is feeling the effects. Banks with exposure to European debt, and the global economy as a whole, may be affected if debt restructuring doesn’t go smoothly.

China’s growth is slowing, impacting the global economy and the recovery of almost every nation. Can the Chinese avoid a hard landing on one hand, and avoid inflationary over-stimulation on the other hand? We’ll see.

What we think
We’d summarize the first quarter and the outlook going forward with two words: wary confidence. There might be some slowdown and market volatility. Oil prices will affect the economy. Fixed income has been a haven for investors, but that may be changing. Interest rates are likely to rise, and the 30-year bull market in bonds will become more bearish. And, as always, a diversified portfolio is a prudent hedge against unpredictable events and a good long-term strategy for investors.


Wealth Enhancement Group

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Our “One and a Half Cents” on the Fourth Quarter – Part One

January 4, 2011

The stock market posted strong gains during the third quarter after rebounding from the low of the year that occurred near the end of the second quarter. The S&P 500 posted an 11% gain for the quarter. The strong gains during the quarter were far from steady. Volatility was high as the S&P 500 moved up and down within a 10% trading range. Cyclical, Mid-Cap, and European stocks fared the best during the quarter:

The highly cyclical Materials, Industrial, and Consumer Discretionary sectors were among the best performers while the legislation-sensitive Financials and Health Care sectors lagged.

According to data from the U.S. Treasury, purchases of U.S. stocks by foreigners in the third quarter of 2010 were likely strong based on the latest data available for July. On average, demand in recent quarters has only been exceeded in the past by the surge in buying around the market peaks in 2000 and 2007.

However, those foreign investors saw almost none of the strong gains in the U.S. stock market translate into their holdings due to the decline in the value of the dollar. The performance of the dollar-denominated S&P 500, when adjusted for the value of the dollar against major trading partners, was relatively flat for the quarter. If foreign investors fear further declines in the dollar, they may restrict their buying of U.S. stocks.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Mid-Term Market Moves – Part 2

October 14, 2010

Since World War II, there have been only two mid-term election years (1978 and 1994) during which U.S. equities did not experience a fourth-quarter rally. During both of these years the Federal Reserve (Fed) was aggressively hiking interest rates.
In 1978, the lead up to the Islamic Revolution resulted in strikes and unrest in Iran. In November 1978, a strike by Iranian oil workers reduced production from 6 million barrels per day to about 1.5 million barrels. At the same time, foreign oil workers fled the country. In the United States, inflation hit 9% in the fourth quarter with no signs of stopping as it approached double-digits. In response to soaring inflation pressures, the Fed was aggressively hiking rates during 1978 with 1.25% of hikes in the fourth quarter alone (the Fed ended the quarter with a policy rate of 10%).
In 1994, the S&P 500 turned in a flat fourth quarter on the heels of a shift in power to the Republicans. However, the performance was less of a reaction to the election results than to rising fears of recession amid the Federal Reserve’s aggressive hiking of short-term interest rates and a corresponding run-up in long-term interest rates (to nearly 8% from below 6% at the start of the year).
We expect the Fed will be on hold until next year, but past performance suggests a headwind for the stock market if the Fed does start to hike late this year.

Mid-Term Market Moves – Part 1

October 12, 2010

So far, the stock market performance in 2010 has tracked the typical pattern for U.S. stocks in mid-term election years, albeit with a bit more than the usual volatility. The path is usually range-bound and volatile, but capped by a strong fourth quarter rally averaging about 8%.

The market’s reaction to mid-term elections has nearly always been positive, even when the balance of power has shifted in one or both houses of Congress—as we expect this year with the Republicans having a good chance of taking the House. In four of the five years that mid-term elections resulted in a change in power (2006, when Democrats took the House and Senate; 2002, when Republicans took the Senate; 1986, when Democrats took the Senate; and 1954, when Democrats took the House), fourth-quarter returns were positive, much like those in mid-term election years when no change in power took place.

Uncertain Fed Means Certain Outcome – Part 3

October 7, 2010

Uncertainty is to be expected given the challenges facing an economy in the early stages of growth following an unprecedented upheaval. The sentiment of unusual uncertainty is expressed in this excerpt from the pages of TIME magazine:
“If America’s economic landscape seems suddenly alien and hostile to many citizens, there is good reason: they have never seen anything like it. Nothing in memory has prepared consumers for such turbulent, epochal change, the sort of upheaval that happens once in 50 years.”

“The outward sign of the change is an economy that stubbornly refuses to recover. In a normal rebound, Americans would be witnessing a flurry of hiring, new investment and lending, and buoyant growth. But the U.S. economy remains almost comatose a full year and a half after the recession officially ended. Unemployment is still high; real wages are declining.”

“The current slump already ranks as the longest period of sustained weakness since the Great Depression. That was the last time the economy staggered under as many “structural” burdens, as opposed to the familiar “cyclical” problems that create temporary recessions once or twice a decade. The structural faults represent once-in-a-lifetime dislocations that will take years to work out. Among them: the job drought, the debt hangover, the defense-industry contraction, the savings and loan collapse, the real estate depression, the health-care cost explosion and the runaway federal deficit.”
This excerpt is from September 28, 1992. The same article quoted an economist as saying, “this is a sick economy that won’t respond to traditional remedies. There’s going to be a lot of trauma before it’s over.” But it was over.
The recession ended in 1991 and real GDP was an above average +3.4% in 1992 (about the same pace of growth the economy has averaged this year). Yet, in September 1992, TIME described the economy as “comatose”. When the article was published, the economy had already been growing for six quarters. Hiring had weakened to averaging only +77,000 jobs per month in the four months leading up to this article, but in the following four months it averaged +210,000. In addition, while the structural problems apparent then seemed unsolvable for years to come, real GDP was +2.9% the following year.

In 1992, the uncertainty expressed in the sentiment from the Fed and in the media at the end of the third quarter set the stock market up for a solid fourth quarter rally after a relatively flat year for stocks in the first three quarters. The stock market in 1992 ended with a modest single-digit total return (including dividends) of 7.6%, very similar to our outlook for a modest single-digit gain this year.

Uncertain Fed Means Certain Outcome – Part 2

October 5, 2010

With the Federal Funds target rate effectively at zero the typical rate cut is not an option this time, so what will the Fed’s uncertainty lead it to do?
1. First, the Fed will likely signal its sensitivity to heightened risk by updating the message from the June meeting that it “will employ its policy tools as necessary” to reflect the latest language from the recent semiannual testimony that it “is prepared to take further actions as needed.” This will send the signal that the Fed has a greater bias toward easing monetary policy. This signal alone may have some of the effects desired by the Fed on the markets.

2. Second, in lieu of the Fed cutting rates, they may reinvest interest and principal payments on the Fed’s holdings of Mortgage-Backed Securities back into the market with the intention of adding money to the system and keeping rates low. However, we believe the Fed is not likely to take this step without a downgrade to its recently stated growth outlook for above-average Gross Domestic Product (GDP) growth in 2011 and a 1% decline in the unemployment rate over the next year. The Fed has the ability to wait on any additional stimulus given the improvement in market conditions, from the stock market to the TED spread, since the last Fed meeting in June. If the uncertainty lingers, and the Fed further downgrades their outlook, the Fed could pursue the path of further easing consistent with prior early cycle periods of uncertainty.

Uncertain Fed Means Certain Outcome – Part 1

September 30, 2010

In his recent testimony to Congress, Federal Reserve Chairman Ben Bernanke used the phrase “unusually uncertain” to describe the U.S. economic outlook. The word uncertain was used five times in the statement released at the conclusion of the June 23 meeting, and was used 16 times in the minutes released on July 28.

The economy again began to grow last summer, putting the current bout of early cycle uncertainty at about four quarters since the end of the recession. In contrast to Chairman Bernanke’s remark, the current uncertainty is not all that unusual at this early stage of an economic cycle. In fact, based on the Fed’s own words, the current level of uncertainty is actually common at this stage of the economic cycle.
• In March 2003, about five quarters after the 2001 recession had ended, the Fed’s Beige Book used the word “uncertain” 30 times to describe the economic environment, almost twice as often as the July 2010 Beige Book. Also, the minutes of the March 2003 Fed meeting used the word “uncertain” 16 times, three times as often as the five times it was used in the June 2010 meeting minutes.
• In October 1992, about six quarters after the end of the 1991 recession, the word “uncertain” appeared 23 times in the transcript of the October 1992 Fed meeting.

The response by the Fed to uncertainty over the economic environment has been anything but uncertain. They have always provided the economy with one last booster shot of stimulus. During the past four decades, the Fed has cut rates one last time well after the recession had ended when a soft spot emerged. For example, related to the above examples of Fed uncertainty, the Fed cut the Federal Funds target rate in June 2003 and in September 1992.