STAY THE COURSE, from Bob Doll, vice chairman and chief equity strategist for fundamental equities at BlackRock
Despite some mixed data over the past couple of months, our view is that the global economic recovery remains on track, both in developed and emerging economies. In the United States, manufacturing, production and business sales figures have risen over the past six months at their strongest rates since the early 1980s, but we have yet to see real improvements in jobs or income growth. The snow storms that paralyzed large areas of the country in February probably mean that the current month¹s numbers will be sluggish as well. Nevertheless, the Institute for Supply Management Manufacturing Survey climbed to its highest level in five years in January, and business sales have been increasing, all of which suggest that corporate profits (and, eventually, the labor markets) should see improvements in the coming months.
In terms of housing, price indicators have been running noticeably above their recession lows in recent months, and we would argue that this translates into a bottom forming for the housing market.
Late last week, the Federal Reserve announced a 25 basis point hike in the discount rate (the rate the Fed charges banks to borrow directly from the central bank) from 0.5% to 0.75%. The Fed tried to emphasize that this increase was unrelated to its broader strategy of maintaining easy monetary policy and restated its long-held mantra that the Fed Funds rate would remain historically low ³for an extended period.² In any case, it does seem clear that the Fed has begun its exit strategy in terms of removing some stimulus, although at this point we would not expect to see an increase in Fed Funds before the end of this year. In related news, inflationary pressures receded last week on data showing that consumer price numbers have remained relatively tame. There was an uptick in producer price inflation, but, overall, inflation has remained under control.
As of now, we have seen two weeks of stock market increases, which have put indices roughly at the mid-point between their January highs and their early February lows. Sentiment remains mixed, with market participants showing little conviction in either direction. The main downside risk continues to be concerns over unresolved leverage and debt issues around the world. We maintain our view that the long-term economic backdrop should be conducive to continued better performance by risk assets, though we believe deflationary pressures and technical factors are likely to keep markets in a trading range over the short term.
A STRENGTHENING BASE CASE, From Alan Levenson, chief economist, T. Rowe Price
The U.S. economy’s turn from stimulus-aided recovery in 2009 to self-sustaining growth in 2010 is premised on the observation that key sectors of the economy cut spending, inventories, and labor drastically and that significant headway in the correction of previous accumulated imbalances have been critical in setting up a firmer footing for future growth. As the labor market begins to add jobs this year, a healthier composition of growth will begin to emerge, led by business fixed investment, consumer spending, and housing.
A rebound in business fixed investment is underway
Equipment purchases rose 13.3% in Q4, the fastest rate of growth since the beginning of 2006, and shipments of nondefense capital goods excluding aircraft (used to estimated business purchases of nontransportation equipment in the GDP accounts) rose 2.1% in December, capping the strongest three-month advance in almost five years. Additionally, with backlogs stabilizing and in some sectors beginning to rise, our forecast of sustained recovery over the course of 2010 is guided by the assumption that aggressive cutbacks in fixed investment in 2008-2009 conserved cash, but may have overshot to the downside: plant and equipment outlays are at a record low relative to depreciation.
Labor market recovery is on schedule and will gradually gain momentum
The U.S. economy culled 8.4 million jobs in 2008-2009, as businesses reacted swiftly and persistently to the 2008 credit market shocks. The rate of employment loss is easing, and we anticipate that job growth will resume in the current quarter and gain momentum over the course of 2010; as pro-cyclical productivity gains fade, labor inputs will rise to meet product demand. Our forecast is for nonfarm payroll employment growth to rise toward 2000,000 per month by the end of 2011, and for the unemployment rate to fall to 9.5% at the end of this year and to 8.5% at the end of 2011.
An improving employment trend will reinforce the recovery in personal income, supporting modest consumer spending gains even as household sector deleveraging continues in 2010. We are forecasting that the personal saving rate will rise to just over 6% over the course of this year, and stabilize at that level in 2011.
Absorption of supply overhang constrains housing sector from a more vigorous rebound
Since falling to an all-time low 479,000 unit annual rate in April 2009, housing starts have risen slowly – the January pace of new construction (591,000 units) is still only half the pace necessary to meet the demands of a growing population over time. Historically, steep downside overshoots in housing construction take just 1.5 years from the trough to return to equilibrium, but the unprecedented inventory overhang leads us to anticipate a three-year recovery to 1.25 million housing starts by 2012, limiting housing’s contribution to growth to ½ a percentage point per year.
NICE TO SEE THE CREDIT CRUNCH IS OVER, from David A. Rosenberg, chief economist & strategist, Gluskin Sheff
The FDIC was a hungry beast on Friday and ate up four more regional banks, with La Jolla being a big catch at $3 billion of assets. This brings the number of U.S. banks that have failed so far this year to 20 and that compares to 13 at this same stage a year ago when practically everyone feared the world was coming to an end (but before Geithner and Bernanke declared that any bank that was thought too big to fail would not be allowed to).
The Fed chose to raise the discount rate even as the money multiplier hit a new all-time low and in the same week that bank credit contracted a further $9 billion, which brings the year-to-date decline to $115 billion, or a 14% annual rate, with every component from mortgages, to consumer credit, to business lending shrinking. There is no way the Fed is hiking the funds rate with bank credit in secular decline and all bets are off on the sustainability of any recovery; a sustainable recovery without bank credit growth — that will be a new one. Wall Street economists are now waxing about a business investment recovery; however, what they don’t tell you is that almost all of the contribution the rebound in capex generated to the Q4 real GDP headline was offset by commercial construction and State and local government spending, which are both in secular decline.
THE ENERGY ETF PLAY, from Tom Lydon, president, Global Trends Investment
You’re using energy to read this right now, you probably used energy to get to work this morning and you’ll use energy to heat your home at night. Exchange traded funds (ETFs) offer a simple and efficient way to capitalize on the world’s energy appetite.
As gasoline prices rise and natural gas prices go through the roof, there is a way to hedge your increasingly exorbitant utility bills. An ETF can help investors hedge rising energy prices, capitalize on profits big oil is making and also give some padding to a portfolio.
Commodity ETFs vary in their construction: some hold futures contracts, others track a basket of equities. With futures-based ETFs, there are tax consequences to be aware of. Contango and backwardation can affect these funds, as well.
Please note how commodity ETFs work, as many are invested in a futures contract rather than actual shares. Some of the futures-invested funds are producing either a positive or negative yield roll, and may not yield the proper results.
SHOW US YOUR ASSUMPTIONS, From Stephen J. Huxley, Ph.D., chief investment strategist, Asset Dedication
At the T3 financial-advisory technology conference in San Diego last week, one session focused on the theoretical underpinnings of software that advisors use to support their financial planning efforts (think MoneyGuide Pro, Naviplan, Money Tree, etc.). This was an excellent choice of topics; many advisors have only a hazy understanding of the assumptions that underlie the software they use. A few highlights can provide some interesting insights.
First, most software assumes there is some ideal asset allocation for a client that captures their true risk/return preference (based on highly questionable risk tolerance questionnaires), and that the portfolio should be rebalanced to that ideal on a regular basis. Unfortunately, this blind allegiance to MPT seems unwarranted, given the recent advances in postmodern portfolio theory, behavioral finance theory and dedicated portfolio theory. Footnotes citing where these competing theories might lead to different conclusions would be welcome additions to existing software, or at least links to references for those who are interested.
A second underpinning is that all fixed income is the same: Individual bonds or bond funds are assumed to be equivalent. That is simply wrong. Individual bonds, held to maturity, provide one of the few certainties in the world of finance: a perfectly predictable stream of protected income. In fact, US TIPS offer the closest thing to guaranteed predictability, including inflation, as you will ever get in any financial investment. Bond funds, because they are buying and selling bonds all the time, strip out this vitally important predictability that individual bonds can bring to any portfolio. But most software is blind to this distinction.
Other underpinnings that warrant mention include the fact that software generally assumes that all non-financial issues have been handled elsewhere, that the termination age for the plan is rational, and that people really understand what it means when they say that an 80% probability of success is acceptable to them. Any advisor who had to confront angry clients after their portfolios dropped 20% over the past couple of years can tell you otherwise.
This summary only scratches the surface of this particular session, at what was a very lively conference. Advisors who want to stay on the cutting edge of their profession would do well to attend this conference next year, in Ft. Lauderdale.
REPORTS CALENDAR
Monday, February 22:
Tuesday, February 23: December ’09 S&P/Case-Shiller Home Price Index; February Consumer Confidence; February Investor Confidence Index
Wednesday, February 24: Mortgage applications
Thursday, February 25: January durable goods orders
Friday, February 26: Fourth-quarter GDP; University of Michigan Consumer Sentiment Index; January existing home sales
