The View from the Top?

A few weeks ago, the S&P 500 closed at a record high of 1669, while most recently the index has given back some of these gains. Naturally, investors may be concerned with how fast the market has gone up in the last 6 months, not to mention dire headlines predicting that with our current fiscal situation the only fate of investment portfolios is to go lower. While people may feel great about this recent charge, it also can create a swirl of questions:

• After such a strong rally, and with the federal deficit so large, won’t market chaos emerge soon, sending equities and bonds into a downward spiral?
  
• Should we sell our assets to take profits while we still can? 

But, perhaps you should take a step back for a moment and think about how you should react with your portfolio with some different questions:

• Has your time horizon been altered?
  
• Have your liquidity needs changed? 

If you have the same time horizon and liquidity needs as you did when you established your financial plan, chances are you shouldn’t be thinking “what’s going to happen to stocks this summer,”—you should be thinking, “what’s going to happen to stocks over the next five to ten years?”

I can’t predict when the market will break through the all-time record high it set a few weeks ago, and I’ll put money on the fact that you can’t either. As a prudent financial professional, what I can do is help prepare for what we know is inevitable – the rise of interest rates.

Interest rates have been at historic lows for a while now. The Federal Reserve has kept rates near 0 percent in an effort to inject liquidity into our financial markets by buying Treasurys, and most recently by buying Mortgage Backed Securities. When the Federal Reserve purchases these bonds from banks, banks are flushed with cash, enabling them to loan to consumers, in turn consumers are able to make purchases on big ticket items such as cars or appliances. Increased consumption helps businesses as they sell more goods and their profits increase.

The Federal Reserve has accomplished this, for the most part. Markets have reached record highs, corporations have attained record profits, consumer sentiment has climbed, and household net worth recently hit record highs as well. Unemployment has dropped 2.5% to 7.6% over the last 3 years. The Federal Reserve’s objective is an unemployment rate target of 6.5%, and a 2% inflation rate. Although it may take another year or two to lower the unemployment rate to the Fed’s target, there is the real possibility that the Fed could begin to sell their bonds back into the market before the unemployment target is reached.

Currently there is nearly $4 trillion on the Fed’s balance sheet, and in order to normalize this, the Fed will have to sell back these bonds, which will effectively start to increase interest rates due to the increased supply in the market. Increasing interest rates would lower bond prices. This could be a bit painful for the market, but if the Federal Reserve waits longer, the deficit will grow larger, and the impact on the market could be worse. The Fed has to be very delicate as to how to sell back these bonds. The bottom line is that no matter what method they use to reduce their balance sheet, bonds will be hurt, but there will be certain bond and equity sectors that will hold up better than others.

Time will tell, but a review of any potential exposure you may have is important now.

Perspectives from Above the Noise – Week of June 10, 2013

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

U.S. stock indices were on track for a third straight weekly decline, until positive economic data sparked equity markets higher on Friday. International stocks had a bad week; the benchmark MSCI EAFE index dropped 1.14% as Asian equities took a beating. The Hong Kong stock market turned its worst weekly performance in more than a year as Chinese investors grappled with a cash squeeze and weak economic data.

For the week, the S&P 500 gained 0.78%, the Dow gained 0.88%, and the Nasdaq gained 0.39%.

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

Estimating the Trend in Employment Growth

The U.S. labor market has been adding about 175, 000 jobs per month over the past year, below the 200,000 plus some economists believe is needed to drive the unemployment rate meaningfully lower. However, a recent paper from the Chicago Federal Reserve suggests that the real level of job creation needed to keep up with population growth and other factors is closer to 80,000 per month.

Furthermore, the authors go on to argue that this number will decrease over time to the point that by 2016, the economy will only need to create 35,000 per month to keep up with population growth. If this analysis is correct, it would suggest that average monthly job growth of 175,000 is not only enough to cover the rising population, but it would also put downward pressure on the unemployment rate.

U.S. Expansion Poised for Longevity

The economic recovery following the 2008-09 recession has been sluggish relative to prior post-World War II recoveries, as the U.S economy has grown at a modest 2 percent annually over the last four years. The current recovery might lack in strength, but it may have more longevity than prior recoveries with no signs that the economy is overheating.

We are four years into the recovery and inflation remains subdued, household debt is declining, and the labor market is expanding. Based on these factors, Northwestern University economics professor Robert Gordon predicts economic expansion to continue for up to five additional years, which would result in the second longest post-WWII recovery, and double the average length of 58 months.

A Bloodless German Duel Over the ECB

A Bloomberg opinion piece by Megan Greene examines the potential outcomes of a ruling expected this week from Germany’s constitutional court that has important implications for the euro. The German court is meeting June 11-12 in order to determine the legality of a program of bond-buying by the European Central Bank (ECB) called outright monetary transactions. The prospect of outright monetary transactions by the ECB has helped calm sovereign debt fears in the region over the past six months and a rejection of the program by the German court could have a destabilizing impact.

However, the author argues that the most likely outcome is the German court will approve the ECB’s program but require further clarification and conditions that will limit Germany’s exposure. Such an outcome should be relatively non-eventful for global markets and may explain why investors have not been more worried about this important German court decision.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of June 3, 2013

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

Markets rose early last week on a couple of lukewarm economic reports, which raised expectations that the Fed will be forced to continue to bolster the economy with its quantitative easing program. The last weekly jobless report for the month showed an increase in unemployment claims, meaning job growth looks to have been essentially flat over the last two months.

Markets ended the shortened trading week down, battered by selling pressure and volatility around possible Fed actions. For the week, the S&P 500 lost 1.14%, the Dow slid 1.23%, and the Nasdaq trimmed 0.09%.

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

'Underlying Bullish Story' for Stocks: Strategist

U.S. equities were able to record their strongest May performance since 2009, despite ending the month with the worst one day decline in nearly two months. U.S. equities have not had a correction this year and finished in positive territory each of the first five months this year.

Although a correction could be in store, Thomas Lee, JP Morgan's chief equity strategist, feels U.S. equities have more upside because the "underlying bullish story for stocks remains intact." He points out there is a shift in momentum from defensive stocks to cyclical stocks, continued strengthening in the housing sector and the wealth effect from rising stock and home prices is helping the American consumer.

April Case-Shiller Composite to Show Annual Appreciation Above 12%

A blog posting on the real estate site Zillow.com provides some interesting insight on the Case-Shiller Home Price Index, which Zillow has begun forecasting in advance (and fairly accurately so far) using their own housing data. The Zillow model expects that next month's Case-Shiller Index will show an eye-catching 12.1% year-over-year rise, which may provide further optimism regarding the housing market's strength.

However, Zillow also makes the important observation that the recent rate of appreciation in the Case-Shiller Index is being driven by a bias toward large, coastal cities currently seeing large price gains and by the inclusion of distressed sales, which are seeing very large year-over-year gains. As a result, the current magnitude of the gains in the Case-Shiller Index is likely to be fleeting and appear far more pedestrian by next year.

Auto Sales Continue to Be Economic Bright Spot

Record energy production coupled with a sustained housing recovery are pushing pickup sales to the highest level in as much as eight years and driving Detroit's comeback. This latest report is encouraging since pickup sales are often viewed as an indicator of the health of small business activity. Fueled by low-interest rate car loans, light-vehicle sales have picked up every month this year. An official at General Motors said that "if we use our sales as a barometer, it appears that the recovery is becoming even more broad-based".

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of May 27, 2013

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

Fed officials went into a full-court communications press as markets wobbled on fears the Fed might begin shuttering its bond-buying program. To counter these worries, Fed officials stressed that there is no rush to exit and that the program is not on “autopilot;” rather, bond purchases will be scaled up or down as future conditions warrant.

While markets reacted poorly to the Fed’s news, economic data last week was generally positive. Stocks entered the holiday weekend down on worries that the Fed might cut back its quantitative easing. For the week, the S&P 500 dropped 1.07%, the Dow lost 0.33%, and the Nasdaq lost 1.14%.

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

Home Prices Accelerate by Most in 7 Years

Markets opened for trading on Tuesday well over 1 percent as news of a jump in home prices fueled buying. The S&P/Case Shiller Index, which tracks 20 metropolitan areas, climbed 10.9 percent, the biggest increase in seven years. Prices also gained 1.1 percent over last month’s report, which tracked March prices. Lower inventories and growing demand are causing higher prices. While many remain worried about fiscal tightening in Washington, the jump in home prices and surge in consumer confidence reveal a resilient economy.

Defending the Bull

Some analysts and market prognosticators are becoming skeptical over the sustainability of the current bull market, following the first weekly decline in the S&P 500 in five weeks. U.S. equities could very well be entering a market correction following a 16.6 percent increase since the start of the year for the S&P 500, but there are a lot of reasons for optimism both short- and long-term for U.S. equities.

As an article in Barron’s recently stated, “Private employment is up. Public spending is down. The deficit is shrinking. Companies are flush with cash. Housing has begun to grow again, as has U.S. manufacturing. And last, but not least, the U.S. may be on the verge of energy independence.” All of the factors listed are positive for U.S. equities.

At Last, Germany Secures Total Dominance of Europe

In a recent Bloomberg op-ed piece, Jim O’Neill, the outgoing chairman of Goldman Sachs Asset Management, provides an interesting way to think of German dominance in the European economy: the success of German soccer clubs in European competition. Much like the European economy, German clubs have become more dominant over the last few years against their neighbors. They have beaten English, Spanish and Italian rivals, and this weekend’s Champions League (European club tournament) final was played by two German clubs.

The strength of German clubs doesn’t just apply to on-the-field performance. Fiscally, they are in much better positions than clubs in Spain, Italy and England. While not perfect, the fiscal metaphor can explain much of Germany’s economic resurgence as its neighbors struggle.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of May 20, 2013

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

Markets experienced some volatility early last week as stocks pulled back amid worries that the Fed may be tapering off its bond-buying program soon. However, investors soon regained their positivity after realizing that the Fed would not slow its quantitative easing activities without a simultaneous improvement in economic growth. In other good news, data showed that consumer sentiment is on the upswing, reaching its highest level since July 2007, according to the Thomson/Reuters University of Michigan inde.

For the week, both the S&P 500 and Dow Industrials hit new highs—the S&P 500 gained 2.07%, the Dow increased 1.56%, and the NASDAQ added 1.82%.

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

Gross to Buffett Omens Disregarded as Bond Sales Soar

A recent Bloomberg article details the very robust corporate credit markets, with sales of corporate bonds in the U.S. heading toward a record for the month of May. With yields still near historical lows and investor appetite for bond deals extremely strong, corporate issuers are aggressively acting to shore up any potential liquidity concerns with the majority of recent issuers citing refinancing among their use of proceeds. As noted in the article, the number of junk-rated companies that are under liquidity stress is now very low, an indication of the extent that corporations have been able to shore up any near-term liquidity concerns by accessing credit markets.

Japan Inc. Should Take a Look in the Mirror

Japan has been one of the strongest stock markets this year as new Prime Minister Shinzo Abe has implemented aggressive monetary and fiscal policies in the hopes of devaluing the yen and spurring economic growth. A recent Bloomberg op-ed piece by William Pesek argues that for these policies to work, Japanese leadership at the corporate and political levels must make some drastic changes. Specifically, Pesek writes about "willful blindness," which can be understood as the refusal to admit to mistakes in the past and lay the groundwork for future relationships with Japanese trading partners. Examples of this at the government level include nationalistic comments regarding World War II which provoke and incense China. At the corporate level, there is much resistance to restructuring meant to produce a more transparent environment. While a weaker yen may boost the Japanese economy in the short run, there are many structural issues that need to change for Abenomics to reap long term rewards.

Economists Predict Increase in Consumer Spending

The National Association for Business Economics surveyed 49 economists at the end of April and the results show increased optimism for accelerated consumer spending this year, helping offset a contraction in government spending. Economists elevated their consumer spending growth forecast to 2.3% for 2013 from their prior prediction in February for growth of 1.9%. Overall, economists predict solid growth in auto sales, housing and corporate profits. The consensus view among economists is for auto sales to increase to 15.4 million units in 2013 compared to 14.4 million units sold in 2012, home prices to increase by 4.4% in 2013 and 4% in 2014, and for corporate profits to improve by 5.3% this year and 7.5% in 2014. The consensus view remains for the U.S. economy to grow by 2.4% this year and 3% in 2014.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of May 13, 2013

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

Markets turned out another solid performance last week as all three major indices reached new highs. As we near the end of earnings season, 90% of S&P 500 companies have reported in, with 67% beating earnings expectations. If all remaining companies post numbers in line with estimates, earnings will be up 5.3% over the first quarter of 2012.

For the week, the S&P 500 added 1.19%, the Dow gained 0.97%, and the Nasdaq increased 1.72%.

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

Are Stocks Cheap? A Review of the Evidence

While the rising stock market has many concerned that financial markets are becoming overheated due to the Fed’s policies, a recent study published by the Federal Reserve Bank of New York suggests that the equity market is trading at its most undervalued levels ever.

In the study, the authors surveyed banks, economists and central banks around the world regarding their preferred models of equity risk premiums. Using a weighted average of 29 models, the authors found that “we will enjoy historically high excess returns for the S&P 500 for the next five years.” While the study contains a number of qualifiers, it is interesting on several levels, including its implied message regarding the future of U.S. monetary policy if the Fed believes equity prices are undervalued.

Oil Plunge Cools U.S. Import Prices in April, Tames Inflation

After years of quantitative easing and Fed-induced liquidity, many are worried about the prospects of rampant inflation in the future.

However, the data continues to show inflation is not a concern for the economy right now. Import prices dropped in April as a result of cheaper energy prices. As long as inflation remains subdued, the Fed will have less of a reason to discontinue its current easy monetary policies.

U.S. Economic Path since ’07 Proves Superior to EU Slump

The United States and Europe have traveled down separate paths since the 2007-2009 recession. The United States implemented a stronger and more immediate response to the financial crisis and focused on bank liquidity and strong fiscal and monetary stimulus. Europe, on the other hand, was less urgent in its reaction and focused on austerity over fiscal stimulus. The U.S. plan was more effective.

Today, the U.S. unemployment rate is 7.5 percent, which is high relative to other post-World War II recoveries at this stage, but much lower than in Europe, where unemployment is at 12.1 percent. Additionally, the U.S. is achieving positive GDP growth and expansion in manufacturing, while Europe is stuck in another lengthy recession and is suffering from a contracting manufacturing sector.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of May 6, 2013

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

Perspectives returns today after a brief vacation week. While I was away, the Dow Jones Industrial Average popped over the 15,000 mark--continuing to set new records.

U.S. markets closed out last week with a bang, after a better-than-expected jobs report eased concerns about a stalled economic recovery. For the week, the S&P 500 gained 2.03%, the Dow gained 1.78%, and the Nasdaq gained 3.03%.

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

Diminished Housing Wealth Effect Keeps Pressure on Fed

In previous recoveries the “wealth effect” from rising home prices provided a strong boost to consumer spending, helping drive faster economic growth. The wealth effect from rising home prices is present in this recovery, but the impact has weakened. In prior recoveries, each dollar increase in house value generated roughly $0.03 to $0.05 of spending, but has dipped to roughly $0.01 of spending in the current recovery.

One reason is tighter credit standards, which have limited refinancing opportunities for homeowners to lower their monthly payments. Additionally, homeowners are not tapping into their home equity as much. Positively, rising home prices have increased homeowner equity from $6.2 trillion in 2009 to $8.2 trillion at the end of 2012.

Look at the Doughnut, Not at the Hole

In a recent MarketWatch piece, Irwin Kellner breaks down the most recent jobs numbers. At first glance, things appear to be improving. The unemployment rate has declined steadily, now at 7.5 percent. Jobless claims also continue to decline, with last Thursday’s report coming in at the lowest level since early 2008.

However, other measures of economic health, such as the labor force participation rate and the employment to population ratio, are either declining or flat because many people have stopped looking for work. In a healthy economy, these measures would rise after a recession. While recent nonfarm payrolls and jobless claims are encouraging news, other measures of employment need to show progress as well before the U.S. labor economy can be considered back on track.

A Tandem in Trouble

A current article from The Economist focuses on the growing political tension among the core of the eurozone, in particular between Germany and France. Although the relationship has always been strained, the article describes growing signs that the French are moving toward closer political ties with the troubled southern countries and pushing away from German austerity. The complicated and increasingly fractured relationship among Europe’s core adds to the region’s numerous economic challenges and may lead to increased market volatility in the second half of 2013. 

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.