Perspectives from Above the Noise – Week of March 25, 2013

3 Stories in the global economy that should not go un-noticed

Markets finally snapped their winning streak last week on concerns of Eurozone trouble. Cyprus desperately needed Eurozone bailout money to recapitalize its failing banks. The Cypriot parliament voted down the original Eurozone proposal that would have taxed all bank accounts to raise additional funds, but was able to clinch a last-minute deal with international lenders that will recapitalize the country’s ailing banks with €10 billion in rescue funds.

On the home front, Congress finally ended the threat of government shutdown by approving a bill funding the government through the end of 2013. While sequestration cuts are still ongoing, the bill will ease some of the pain of mandatory cuts.

For the week, the S&P lost 0.24%, the Dow slid just 0.01%, and the Nasdaq trimmed 0.13%.

Here are the 3 stories this week that rose above the noise:

Home Prices in 20 U.S. Cities Climb by Most Since June 2006

The recovery in the housing sector remains on track, as this morning’s S&P/Case-Shiller report showed property values in its 20-city index rose 8.1 percent in January 2013 from January 2012, the largest year-over-year growth since June 2006. Gains were broad-based, with all 20 cities in the index showing a year-over-year increase, led by a 23.2 percent surge in Phoenix.

Average home prices are now back to their autumn 2003 levels, though that still leaves them down about 30 percent from the 2006 peak. Home inventories also remain at low levels as the supply of homes for sale sat at 1.94 million in February, more than a million units less than the average in the five years leading to the 2007-2009 recession. Historically low mortgage rates should continue to spur future housing demand may lead to further increases in home values.

Stocks Still More Attractive Than at Prior Peaks

Prior to this year, the S&P 500 eclipsed 1550 in 2000 and 2007, but equities are priced more attractively today than during the two prior peaks, as Seth Masters points out in this Barrons’ article. Currently, the S&P 500 is trading about 13.7 times the forward 12-month’s earnings, below 15 times forward earnings in 2007, and well-below 25.6 times forward earnings in 2000.

Additionally, the yield on the U.S. 10-year Treasury has dropped from 6.2 percent in 2000 to 4.4 percent in 2007, and is currently below 2 percent. The low interest rate environment is driving investors into riskier assets, including equities, in order to generate higher returns. The dividend yield on the S&P 500 index is above the 10-year Treasury yield today, but was significantly below 10-year Treasury yields in 2000 and 2007.

Sympathy for the Devil Named Angela

A recent article in the Wall Street Journal gives an interesting perspective on the politics of the recent crisis in Cyprus, shedding light on European politicians’ inability to deal effectively with their ongoing sovereign debt crisis. Lately, economists have asked why the gap is so wide between what is good policy and what the public will support.

According to the article, most Europeans, even today, would be better off if over-indebted governments were allowed to default in accordance with the relevant bankruptcy precepts. But it apparently can't happen in societies so trained to look to politicians to overrule the laws of arithmetic and economics whenever those laws are inconvenient.

Perspectives from Above the Noise – Week of March 18, 2013

3 Stories in the global economy that should not go un-noticed

Over the last 2 weeks, markets experienced the best winning streak since 1996, with ten days up in a row, while the S&P 500 inched within 10 points of its historical high before closing lower on Friday. We’re disappointed to report that lawmakers don’t appear to be making any headway on the sequestration front. President Obama met with House Republicans last week but made little progress in convincing them to accept tax increases as part of a deficit reduction plan. With criticism flying from both sides, it seems that they are still too far apart to hope for a deal. On a more positive note, the number of Americans filing new unemployment claims fell for the third straight week, indicating that the labor market is recovering steadily.

For the week, the S&P 500 gained 0.61%, the Dow gained 0.81%, and the Nasdaq gained 0.14%.

Here are the 3 stories this week that rose above the noise:

Workers Saving Too Little to Retire

The Employee Benefit Research Institute released a report today which showed that individuals and companies are both struggling to fund retirement obligations. Over the last 30 years the portion of private-sector U.S. workers covered only by defined-benefit plans has fallen from 28 percent in 1979 to 3 percent in 2011.

However, of late, pension obligations for all publicly traded companies based in the U.S. has risen from $1.6 trillion in 2008 to $1.93 trillion in 2012. This increase has been driven by low interest rates and longer life expectancies, two factors which also have the same effect on individuals who are having difficulty accumulating the funds needed for retirement.

Inflation: ‘What, Me Worry?’ Says the Fed

In a recent op-ed piece, Marketwatch’s chief economist Irwin Kellner argues that the Fed should start shifting more of its attention from concerns over unemployment to inflation. While U.S. employment has been improving, many of the measures the Fed has taken may be leading to the beginning stages of inflation.

The producer price index and the consumer price index both recently rose 0.7 percent for the month of February, which, if they remain at this pace, would lead to an annual rate of 8.5 percent. Stocks, real estate and metal markets have all risen considerably since the Fed started its low-interest-rate policy. Unless the Fed starts to focus more on the side effects of its recent policy moves, Kellner argues that consumers, especially savers, will continue to be hurt the most.

A Bank Levy in Cyprus, and Why Not to Worry

Global markets were roiled over the weekend when news broke that the European Union and the International Monetary Fund planned to take money directly from bank depositors as part of a bailout of Cyprus. Fears of a loss of confidence in the European banking system leading to widespread bank runs were widely discussed in the financial media in the immediate aftermath of the news. However, so far there has been little evidence of the banking crisis spreading beyond Cyprus.

Andrew Ross Sorkin of The New York Times wrote about why the reaction to the potentially shocking headlines has thus far been very muted. The author explained the unique circumstances of the country’s banking system that make it unlikely the terms imposed in Cyprus would ever be considered for larger European countries. There is still some concern that the situation in Cyprus could spread throughout the European banking system and this article provides a good argument for why that outcome should not be viewed as a high-probability event.

Perspectives from Above the Noise – Week of March 11, 2013

3 Stories in the global economy that should not go un-noticed 

Markets made history last week as the Dow set an all-time high above 14,400 and the major indices all posted solid gains, buoyed by strong employment numbers and renewed confidence in the economy. The jobs report was the big market mover of the week, with employers adding a greater-than-expected 236,000 workers to their payrolls in February, and the jobless rate falling to a four-year low of 7.7%.

For the week, the S&P 500 gained 2.17%, the Dow gained 2.18%, and the Nasdaq gained 2.35%.

Here are the 3 stories this week that rose above the noise:

Americans Absorb Payroll-Tax Rise to Keep Spending: Economy

The U.S. economy appears to be re-accelerating in the first quarter, despite immediate headwinds including increased payroll taxes and scheduled government budget cuts. Consumer spending has maintained its upward trajectory, aided by a combination of decreased savings, faster employment growth, rising home values and stock prices that have reached a new all-time high in the U.S.

The rise in big-ticket purchases, including cars and light trucks, is an especially encouraging sign for the economic recovery. Auto sales were over 15 million annualized the previous four months, after failing to eclipse that level for nearly five years.

The Future for Luxury Car Sales in China Looks Bright

China’s passenger-vehicle market had its strongest start since 2010, rising 20 percent to 2.84 million units in January and February of 2013, according to the China Association of Automobile manufacturers. A recent article in The Economist looks at the luxury automobile segment in China and suggests the future is bright for sales to the world’s second largest market for premium cars.

It estimates that China will surpass the United States by 2020 to become the world’s biggest luxury automobile consumer. The surge is mostly due to the rising affluence of its private consumers, including women and younger drivers. According to consultancy firm, McKinsey & Associates, China will have 23 million affluent households with a disposable annual income of at least 540,000 yuan ($72,000) by 2020.

Growth and the Markets

One challenge for investors in recent years has been the seeming divergence between strong equity markets and generally weak economic growth. A blog post from The Economist.com’s Buttonwood blog presents some evidence that this divergence is not at all unusual.

Several studies are cited which indicate no statistically significant correlation between economic growth and market performance for numerous countries over long time frames. Although we believe a focus on macro issues plays an important role in risk management, the economic backdrop is ultimately only one piece to the investing mosaic and some of the statistics presented in the post make a good case that strong economic growth has not generally been a prerequisite for strong equity markets.

Perspectives from Above the Noise – Week of March 4, 2013

3 Stories in the global economy that should not go un-noticed 

As many expected, the sequestration deadline came and went on March 1, demonstrating Washington’s unwillingness to compromise on either side of the issue. With no deal in sight, President Obama formally ordered the start of $85 billion in government spending cuts Friday evening. Markets shrugged off the sequestration deadline, perhaps trusting that lawmakers will pull themselves together before the full weight of the cuts are felt. Although spending cuts have been ordered, it will take time for the gears of government to turn, and the major effects may not be felt until early April, when the first furloughs begin.

Fed Chairman Ben Bernanke made several speeches last week with a clear message: The Fed will keep long-term interest rates low to encourage economic growth. Despite some dissension in the ranks, the Fed will continue its program of loose monetary policy while closely monitoring financial markets to curb inflation risks.

While Friday’s sequestration deadline weighed on investor nerves, markets still ended the week in the black, with the S&P 500 gaining 0.17%, the Dow gaining 0.64%, and the Nasdaq gaining 0.25%.

Here are the 3 stories this week that rose above the noise:

U.S. Oil and Gas Boom Takes Many by Surprise

U.S. oil production has increased rapidly in recent years, growing by 40 percent since 2008 to reach its highest level in two decades. The sharp increase in production is largely the result of hydraulic fracking, which allows the extraction of once unreachable oil and gas reserves.

The U.S. may become the world’s largest producer of oil by 2020 if the oil production boom continues, according to the International Energy Agency. The rapid rise in oil and natural gas production has helped the U.S. manufacturing sector become more competitive globally, as firms look to “in-source” to take advantage of an abundance of cheaper energy sources, among other factors.

Service Industries in U.S. Grow at Fastest Pace in a Year

The Institute of Supply Management (ISM) Non-Manufacturing Index for February rose to its highest level in a year with a reading of 56 versus 55.2 in January (readings above 50 signal expansion, while reading below 50 signal contraction). Although not as widely followed as the ISM Manufacturing Index, this article from Bloomberg.com notes that service industries make up approximately 90 percent of the U.S. economy.

The continued strength in non-manufacturing activity indicated by the ISM survey provides additional evidence that the rebounding housing market and generally improved consumer balance sheets are helping support consumer spending and offsetting the headwinds of the payroll tax increase and rising gasoline prices.

More Stocks, Fewer Bonds

A recent piece in Barron’s discusses findings from their recent survey of 40 of the largest wealth-management businesses. In aggregate, wealth managers are increasing their equity allocation and reducing their bond allocation, with the driving force being the fear that interest rates are heading higher.

On the equity side, investment managers have increased their exposure to foreign equities with larger allocations given to Europe, Japan and emerging markets. Two-thirds of the firms surveyed reduced overall fixed-income holdings from a year ago, with lower weights seen in the Treasury and high-grade corporate spaces. To make up for yield, managers are using high yield, emerging market debt, and alternative investments.

Brief Perspective on Sequestration

If you’ve been watching the news, you’ve probably heard a lot about “sequestration.” We understand that many of our clients are concerned about the effect of these spending cuts on the economy and their financial future. 

Sequestration refers to the $85 billion in automatic federal government spending cuts that are scheduled to begin today, March 1.

A Brief Background

The Budget Control Act of 2011 established caps on federal spending designed to reduce the national debt and established a new debt ceiling, which is the federal government’s borrowing limit. The U.S. hit its borrowing limit on December 31, 2012. If lawmakers were unable to agree on deficit reduction measures and raise the debt ceiling, sequestration would kick in on January 1, 2013 and institute mandatory federal spending cuts across all aspects of governmental operations. These cuts formed part of the “fiscal cliff” debates in late 2012, and the American Tax Relief Act of 2012 reduced the size of the sequestration from $109 billion to $85 billion and postponed the deadline until March 1.¹

In order to pay the government’s bills, the Treasury has implemented temporary measures. In order to resolve the situation and avoid sequestration, Congress and the White House must agree to either raise the debt ceiling or adopt measures to reduce spending or increase revenue. Otherwise, the U.S. risks defaulting on some of its financial commitments.

Sequestration and the Economy

Sequestration would not be catastrophic for the large and robust American economy. However, these automatic spending cuts would cause major disruptions to government activities and cut payments to government-funded organizations (many of whom are in the defense sector). Worse, the cuts are arbitrary and widespread, meaning that agency heads are unable to pick and choose where to trim spending.

While the total economic cost of sequestration is unknowable at this point, some economists estimate that sequestration would contribute to the loss of 700,000 jobs (including drawdowns in the armed forces) and shave 0.6% off of GDP this year.²

While this may seem like a small cost to pay, slower growth, increased unemployment, and reduced consumer confidence may drag out the economic recovery even longer.

What Does This Mean for Investors?

If the sequestration deadline arrives without Congressional action, we expect a period of market volatility will follow. Markets have already reacting nervously to the prospect of spending cuts and a potential U.S. default on its debt obligations. However, we do not believe that default is likely and, even as the spending cuts hit, lawmakers will strike a deal when they begin to feel the pain of sequestration.

With respect to long-term investing, sequestration is simply a bump in the road. In December, all anyone could talk about was the fiscal cliff and how badly markets would be affected. However, as of February 22, 2013, the Dow has gained 6.84% since the beginning of the year.³

As financial advisors, we focus on building long-term wealth for our clients. While short-term market movements may provoke anxiety, we have learned to seek out opportunities in many market conditions; good and bad. 

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¹http://www.ibtimes.com/cost-sequestration-700000-jobs-may-be-lost-across-board-budget-cuts-through-2014-gdp-growth-may-slow
²http://www.ibtimes.com/cost-sequestration-700000-jobs-may-be-lost-across-board-budget-cuts-through-2014-gdp-growth-may-slow
³Source: Google Finance