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

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

Stocks climbed again as the S&P 500 and Dow notched their seventh straight week of gains on positive economic data. Optimistic economic data was behind a lot of the market movement last week. Initial jobless claims fell to their lowest level since the government shutdown; though seasonal factors may have affected the data, the four-week moving average (a less volatile measure) supports the trend.

For the week, the S&P 500 gained 0.37%, the Dow rose 0.65%, and MSCI EAFE (developed international) fell 0.01%.

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

Buying Stocks at Record Highs: Will You Be Sorry?

The Dow closed above 16,000 for the first time last week and there is a wide range of opinions about how attractive U.S. equities are at the current level. For example, billionaire hedge fund manager Carl Icahn is “very cautious” on U.S. stocks, while Warren Buffett feels that U.S. stocks are valued in a “zone of reasonableness.”

According to a recent blog post on Wall Street Journal.com, answering the question “How much can I stand to lose before I bail out?” is the key factor for investors sitting on the sidelines and interested in buying equities. Even if U.S. stocks are valued in a “zone of reasonableness,” external factors can drive stocks into a bear market, where 20 percent or more losses occur. The article states, “…the best indication of whether you can take such a big hit is what you did the last time something similar (bear market) happened. If, in 2008 and 2009, you bought more of any asset that fell in price, you are the rare investor whose intentions and actions may match. If you did nothing, you at least didn’t turn temporary losses into permanent ones by selling out at the bottom. If, however, you did bail out, then don’t fool yourself into thinking you won’t do it again.

Faucets at $1,000 Abound as Home Equity Spigot Opens

One impact of the recovery in housing prices that has occurred over the past two years is a recent resurgence in home equity lines of credit (Helocs). A Bloomberg article details evidence that homeowners are confident enough in home values and the job market to tap into the equity in the homes and banks are becoming more willing to make such loans.

While we don’t expect or wish to see a return to the excessive use of such loans that characterized the years leading up to the housing bust, a modest recovery in home equity loans does have positive near-term economic implications and may provide an economic tailwind in 2014 given the recent run-up in home values.

Market Sees Little Risk of Rising Short-term Rates

A posting on the Econbrowser blog provides a very good analysis of how the market seems to expect the next Fed tightening cycle to play out. Based on the forward curve, market participants are currently pricing in a very low probability that the Fed begins increasing short-term rates before 2015 and sees rates increasing much more slowly after that than they have in prior tightening cycles.

While the prospect of the Fed tapering its quantitative easing program in the coming months may increase financial market volatility, this analysis suggests the Federal Reserve’s communication policy has been effective in setting long-term interest rate expectations which may help limit the impact of its expected tapering announcement.

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

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

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

All eyes were on the Senate confirmation hearings for Federal Reserve chair nominee Janet Yellen last week. The hearing didn’t generate any bombshells but confirmed Wall Street’s belief that the Fed will not be in any hurry to taper its bond-buying programs. Yellen also made it clear that under her leadership, the Fed will take on greater supervision of banks.

Meanwhile, Stocks climbed to record again with the S&P 500 and Dow closing out a sixth straight week of gains despite some volatility. For the week, the S&P 500 gained 1.56%, the Dow rose 1.27%, and the MSCI EAFE (developed international) gained 1.68%.

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

Homebuilder Sentiment in U.S. Held in November at Four-Month Low

The National Association of Home Builders sentiment gauge indicated that homebuilders, as a whole, have a slightly less optimistic outlook for real-estate market conditions than at any point over the last four months. Although homebuilders’ outlook remains positive, their sentiment receded slightly this month because of rising construction costs, declining buyer traffic, and a weaker sales outlook.

Homebuilders’ confidence has come a long way since the depths of the recession when new home construction bottomed at 478,000 units in 2009, well below the average of 1.4 million new homes constructed annually during the pre-recession market cycle. New housing starts are still significantly below pre-recession levels, but are on pace to nearly double this year relative to the 2009 bottom in home construction.

Fed Ponders How to Temper Tapering Without a Rate Increase

One of Janet Yellen’s first challenges as U.S. Federal Reserve Chairman will be figuring out how to cushion against a lurch in interest rates when she pares back the pace of the central bank’s bond buying. After sending 10-year Treasury yields more than a percentage point higher by fueling taper expectations in May and June, policy makers are now grappling with their options when they do reduce debt purchases, likely next year, that have swelled the Fed’s balance sheet to a record $3.9 trillion.

This issue will likely be at the forefront of investors’ concerns in 2014. Current Fed Chairman Ben Bernanke said recently: “We’re in unprecedented circumstances, we’re using policies that have never really been tried before – and multiple policies – and we’re trying to explain to the public how we intend to conduct these policies.”

Small No Longer Looks Quite So Beautiful

A recent article from the Financial Times details the current disagreement taking place among investment analysts regarding the outlook for small-cap equities. From the author’s point of view, the valuation of small-cap stocks has become very stretched relative to large-caps.

However, several prominent strategists believe small-cap outperformance will continue in the intermediate-term due to favorable macro conditions. In our view, with the valuation of small-caps reaching the upper-end of historical norms a modest reduction of small-cap exposure in 2014 seems warranted.

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

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

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

Two major economic reports accounted for a lot of the action last week: a third-quarter GDP estimate and the October jobs report. October employment soundly beat expectations, adding 204,000 new jobs; however, the overall unemployment rate ticked higher from 7.2% to 7.3%. It’s hard to know how accurate the numbers are given the disruption of the government shutdown last month. We’ll know more once November numbers are available.

Despite some volatility, the S&P 500 and Dow hit their fifth straight week of gains, boosted by an unexpected jobs report and a rosy Q3 Gross Domestic Product (GDP) estimate. For the week, the S&P 500 gained 0.51%, the Dow gained 0.94%, and the MSCI EAFE (developed international) lost 0.64%.

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

Beware of Falling Gas Prices

The average price of gasoline nationally is $3.19 per gallon and could fall below $3 per gallon this winter. The recent drop in fuel prices has largely been credited to higher domestic oil supplies from a boom in U.S. oil drilling, but this article makes the argument that lower demand is also having a large impact on lower gasoline prices. Total miles driven by U.S. drivers has increased recently, but is 3 percent below the pre-recession peak in 2007. Many factors are contributing to fewer miles driven in the U.S. including high unemployment, an aging population and a smaller percentage of the population living in the suburbs.

A recent Bloomberg piece points out, “while some analysts are applauding what the drop in gasoline prices means for consumer spending, I am much more concerned with the demand side of the equation. The economy remains filled with soft spots and pockets of weakness.”

New Threat to Japan’s Growth

Central Bank stimulus, or quantitative easing, has become popular in recent years with the most recent example coming from Japan’s economic revival experiment. However, Japan is expected to report this week that “Abenomics” – Prime Minister Shinzo Abe’s master plan involving weakening the yen and temporarily boosting infrastructure spending – is faltering. Economists polled by The Wall Street Journal say Japan’s economy likely posted annualized growth in GDP of only 1.7 percent in the third quarter, slower than the 2.8 percent rate for the U.S. and a sharp deceleration from the 3.8 percent and 4.1 percent rates of the prior two periods.

Since Japan is currently the world’s third-largest economy and the longer-term efficacy of quantitative easing is uncertain, investors will be watching closely to see if Japan’s economic experiment can regain traction in the quarters ahead.

Treasury Yields Climb to Eight-Week High Amid Fed Tapering Bets

Following yesterday’s Treasury market closing for Veteran’s Day, yields on U.S. Treasuries rose to their highest levels in eight weeks, as recent stronger-than-expected economic data has increased the likelihood that Fed tapering may come sooner than initially thought. The market reaction to positive data was most apparent following the November 8 jobs report release. While speculation is that the Fed may begin tapering at its December meeting, the median expectation places that date in March, according to a Bloomberg survey of 32 economists.

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

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

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

Early last week, the FTSE All-World equity index rose to a near six-year high, indicative of the global risk appetite for stocks. But by Wednesday afternoon stocks were modestly weaker after the policy statement from the Federal Reserve was interpreted as less dovish than some had predicted. The Fed did, however, maintain its current pace of highly accommodative bond-buying at this week's meeting, as had been widely expected.

For the week, the S&P 500 gained 0.11%, the Dow gained 0.29%, and the MSCI EAFE index (developed international) lost 1.47%.

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

The Disinflation Phenomenon

A recent post from The Economist Buttonwood blog details the continued disinflationary pressures that are evident in many developed countries, most notably in Europe. With measures of inflation in Europe falling to four-year lows, there is growing speculation that the European Central Bank will take further aggressive steps to ease monetary policy.

As the author explains, global disinflationary pressures are likely at least partially the result of continued contraction in bank credit. Continued low inflationary pressures suggest central banks are likely to maintain very accommodative monetary policy in the coming months.

Americans’ Debt Hangover Seen Ending in Boost to Growth

American consumers have been reducing household debt over the last five years and now appear well positioned to increase borrowing and spending. The percentage of household income that is allocated to paying debt dropped to a record low last year.

The rapid increase in federal deficit spending following the 2008-2009 financial crisis helped offset some of the negative impact on the U.S. economy from consumer deleveraging, but now the federal government is beginning to implement fiscal austerity to shrink the deficit. According to Moody’s Economist Ben Garber, “Consumers taking on more debt at a time when the deficit is shrinking would be a strong positive for the economy. This will help offset some of the fiscal austerity that we’re experiencing.”

Stocks Soar Eerily High: Where does S&P go from here?

A blog post from The Wall Street Journal provides some interesting notes on the current market rally. On the positive side, when the S&P has performed strongly from January through October, the index has historically averaged an additional 5.7 percent gain during the final two months of the year.

One area of concern however is the fact that the market has not seen a 10 percent correction since October 2011 (25 months ago). According to S&P Capital IQ, “since 1946, the S&P 500 has gone 18 months, on average, between 10 percent drops.”

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

Measuring the Effects of Affordable Care Act, a.k.a. Obamacare

The Patient Protection and Affordable Care Act, commonly known as the Affordable Care Act (ACA) or “Obamacare,” has been at the center of the recent government shutdown and debt ceiling debates as well as a source of controversy in the media. In order to better understand the issues, let’s delve past the hype and discuss how Obamacare may affect investors and the economy.

What is Obamacare?

Obamacare is a set of health reforms that was passed by Congress and signed into law in March 2010. Considered the biggest extension of federal health care benefits since the establishment of Medicare and Medicaid in 1965, Obamacare will let some 47 million Americans who currently lack insurance to purchase various types of government-sponsored health coverage. The stated purpose of the bill is to increase the number of Americans covered by insurance and decrease the cost of health care in the U.S.

The centerpiece of the health reform bill are the insurance exchanges, where people who do not currently have health insurance will be able buy it. The insurance marketplaces opened for enrollment on October 1, 2013 and the ACA will begin delivering insurance coverage on January 1, 2014. Among other important changes, Obamacare also bars insurance companies from denying benefits based on pre-existing medical conditions like pregnancy, cancer, or disability. Insurers must also justify any insurance premium increase over 10 percent.

Most Americans may not be directly affected by Obamacare. If you’re one of the 80 percent of Americans who get insurance through an employer or the government, it’s very unlikely that you’ll ever directly interact with Obamacare’s insurance exchanges. Obamacare matters most for the 20 percent of Americans who are uninsured or purchase individual private (non-group) insurance. Source: Washington Post Blog

Why is Obamacare controversial?

The ACA has drawn a significant amount of opposition and most of the controversy is due to a fundamental disagreement about the idea of universal health insurance. Opponents to the law think that Obamacare will lead to the disruption of existing health plans, increase the costs of insurance, and result in higher costs to businesses and employers.

There is also opposition to specific aspects of the new regulations, such as the employer mandate, a penalty that will be incurred by businesses with more than 50 employees that do not offer health insurance to their full-time workers. Some economists worry that this provision will act as an incentive for employers to substitute part-time workers, thus having an adverse effect on the labor market. Although the employer mandate has been delayed until 2015, there is already evidence to suggest that some employers are cutting worker hours to avoid falling under ACA provisions.

What does Obamacare mean for investors and the economy?

According to estimates prepared by the Congressional Budget Office (CBO), Obamacare will reduce the federal deficit by $210 billion over the 2012-2021 period because revenue will significantly exceed expenses. A major source of revenue will be higher Medicare taxes, new annual fees on health insurance providers, pharmaceutical companies, and drug manufacturers, a new 40 percent excise tax on so-called “Cadillac” insurance policies, and reductions in Medicare reimbursements for hospitals that don’t meet standards of care. The CBO also believes that the ACA will also extend the solvency of Medicare by an additional 8 years.

On the other hand, economists lack a clear understanding of the effects provisions, like the employer mandate, will have on the labor market, or how Medicare reimbursement rates will affect the healthcare industry. It’s likely that these effects won’t be visible for years.

When attempting to understand how Obamacare may affect you as an investor, it’s important to keep your personal political views in check. Regardless of your opinions about the ACA, there are some objective conclusions that we can draw about how different sectors may be affected:

• Approximately 50 million new health care consumers will be created and demand for medical services and equipment is likely to rise as a consequence. 
• Hospitals will no longer be on the hook for free emergency room care, meaning that they will be able to drastically reduce unreimbursed patient-service costs. 
• Insurance companies will see their earnings and profitability affected by ACA provisions as well as by the addition of previously uninsured Americans. 

Conclusions

It’s impossible to know exactly how the ACA will affect markets, but we know that new regulatory environments often provide opportunities for flexible investors with a long-term outlook. In the short term, uncertainty around the ACA rollout and political debates may lead to increased volatility; however, we encourage our clients to focus on their long-term objectives and not to worry too much about short-term market movements.

We hope that you’ve found this post interesting and informative. If you have any questions about the information we’ve presented or want to know how the ACA may affect your investments, please let us know; we would be happy to discuss your concerns. As always, it is our sincere pleasure to be of service.

Perspectives from Above the Noise – Week of October 28, 2013

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

After a delay of several weeks, investors finally got a look at September’s jobs report and the news was mixed. While the unemployment rate dropped to 7.2%, hiring appears to have slowed. On a more positive note, third quarter earnings have been slightly better than expected with earnings growth averaging 6.8% among the 243 S&P 500 companies that have already reported in. 

Markets extended their post-deal rally for another week, putting up several new records: The S&P 500 closed out the week at another all-time high, while the Nasdaq ended at a 13-year high. No records yet for the Dow, but it’s putting up a good fight, gaining 5.4% over the last 13 trading sessions.

For the week, the S&P 500 gained 0.88%, the Dow increased 1.11%, and the Nasdaq grew 0.74%.

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

Silicon Valley: Feel the Froth

An article from The Wall Street Journal details some signs of excessive speculation beginning to take hold in the technology sector. A number of highly speculative companies with soaring valuations are discussed, an indication that investors’ willingness to take on risk in an effort to generate large gains is reaching potentially concerning levels.

As the authors note, market frothiness remains well below the mania witnessed during the late-1990s, but recent speculative activity could be an early indication that investor psychology has become overly exuberant.

Business Confidence Booms, While Consumer Confidence Slumps

Business confidence is improving among chief financial officers, according to a CNBC survey of CFOs from multinational corporations located in Europe and Asia. Nearly 70 percent of the respondents anticipate an improvement in the global economy over the next six months and only 9 percent foresee a decline in economic growth. Additionally, 56 percent of respondents plan on expanding their workforce and 4 percent plan to implement layoffs within the next six months. The biggest concern over the next six months mentioned in the survey is slowing growth in emerging-market economies. Over 80 percent of respondents mentioned it as a concern.

Meanwhile, consumer confidence slumped according to yesterday’s Conference Board report, which showed a decline in its index to 71.2 from a revised 80.2 last month. It is a disappointing number considering the median forecast in a Bloomberg survey of economists was 75.

The partial government shutdown contributed to negative sentiment in both present conditions and consumer expectations for the next six months. More Americans expect their income to decline over the next six months which coincides with less Americans planning to buy homes and cars. Real-estate sales have begun to ease as higher prices and mortgage rates sideline potential homebuyers.

U.S. Housing Recovery Continues

Home prices in 20 U.S. cities rose in August from a year ago by the most since February 2006 as stronger demand boosted values. The S&P Case-Shiller index of property prices increased 12.8 percent from August 2012, after a 12.3 percent gain in the year ended in July.

The ongoing housing recovery continues to be a source of strength for the U.S. economy especially given the headwinds created by lower government spending due to the sequestration deal struck in Congress late last year. Economists noted that every area reported higher selling prices indicating broad participation in the recovery. As of August, average home prices in the U.S. were back to mid-2004 levels and the 20-city index was up 22.7 percent from its March 2012 low.

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

Washington Fuels the “Creation of Crisis”

It didn’t have to be this way. The latest government crisis in Washington continued to reduce confidence in our elected leaders. I have a phrase I use to suggest the media’s psychological influence on the behavioral way we approach our money and investing—and that is “the Creation of Crisis”. I have made the suggestion on this blog before that Behavioral finance, or balancing fear and greed with a long-term investment strategy, is something each of us struggle with, and 24-hour news television sometimes only adds one more irrational voice in our heads. Well, the media certainly did their part to scare folks as Thursday drew nearer, but the politicians didn’t need much help.

Much of the political wrangling as these deadlines come to pass is focused on the a raise of the “debt ceiling”. This is money that the government has already spent. In my opinion, if there is an argument to be made it has to be about getting future spending in line with current tax revenues—and working on a reform to bridge this gap. This was not done, and here’s more bad news: the deal passed last week maintains the sequester and only funds the government through January 15 and raises the debt ceiling until February 15.

Unfortunately, kicking the can down the road means that we’ll be revisiting the issue again after the New Year. There’s a tremendous amount of mistrust not only between the parties, but also within the Republican Party, meaning that the next fiscal showdown may be just as acrimonious and drawn out.

An eye-popping new report suggests that Congressional budget battles, debt ceiling standoffs, and federal spending cuts have cost the country nearly 3% of GDP growth since 2011 – roughly $700 billion in lost economic growth. Digging a little deeper into the numbers, we discover that spending cuts alone have taken a significant chunk – 0.7% - out of annual GDP growth since 2010. Worse, this is an annual reduction in GDP growth, meaning the effects compound over time.[i]

If the current budget battle morphs into a protracted series of short-term arrangements, raising policy uncertainty in the process, the economy will likely suffer as well. Focus of the argument can and should shift to pragmatic solutions with political consensus.


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[i] http://www.macroadvisers.com/2013/10/the-cost-of-crisis-driven-fiscal-policy/