An optimistic start to a New Year and decade, from JP Morgan, T. Rowe and others. Plus: the week’s reports.
TOPICS FOR CLIENT REVIEWS, From Stephen J. Huxley, Ph.D., chief investment strategist, Asset Dedication
Annual review meetings nearly always include risk as a topic for discussion. So what risks will—or should—be discussed for 2010?
Short-term risks will likely continue to focus on volatility. The market is not likely to experience the same degree of gyration it did in 2009, at least by historical standards. The market has not had this much volatility two years in a row since margin requirements were stiffened to current levels after the 1930s. But the ups, and especially the downs, will be fresh in people’s minds.
What about inflation? Most forecasters believe that it to will be quiet in 2010 because of idle capacity in the economy, as reflected in unemployment figures. For the longer term, however, beginning in 2011 or 2012 and thereafter, the prospects of inflation loom much larger. No one knows exactly when the enormous deficit run-up will begin to cause price increases, but most economists regard it as a ticking bomb.
Rising interest rates are another risk for portfolios heavily invested in bond funds. Those who use bond funds as volatility dampeners may find that falling NAV does not reflect the stability they were looking for.
ON THE ROAD TO RECOVERY, From David Kelly, chief market strategist, JPMorgan Funds
The American economy is far from being back to full health as we enter the first week of 2010. But waking up this Monday, the world looks far less bleak than it did a year ago, and numbers released this week should confirm that the economy remains well on the road to recovery.
The December ISM manufacturing index, due out on Monday, could show a slight decline from November, but should remain well above 50 for the fifth consecutive month, indicating a growing manufacturing sector.
The pending home sales index, due out on Tuesday, is likely to see some relapse from its super-high level of 114 in October (which probably reflected the expected expiration of the first-time homebuyer tax credit), but should still indicate gradual improvement in the housing market. Auto sales are also gradually improving and likely topped 11 million units in December, in the strongest monthly performance since the end of the “cash-for-clunkers” program.
Wednesday’s report on the non-manufacturing sector should show a bounce-back from a suspiciously weak November reading, while Thursday’s initial claims report should confirm the recent very significant decline in layoffs.
As usual, however, the most important economic report for the week and the month will be the jobs numbers due out on Friday at 8:30 AM. The unemployment rate may nudge up reflecting a small reversal of a recent sharp decline in the labor force, while the average workweek should be unchanged and wages should register a small gain.
But it is the payroll employment number, which will be the star of the show. For 23 consecutive months, the U.S. economy has lost jobs with cumulative job loss of 7.2 million. Last month, in a major surprise, the job loss was just 11,000. It is possible that December will produce a job gain—representing the last crucial checkmark on the clipboard of economic recovery.
Payroll employment is, of course, just one measure of the health of the job market—a broader view should confirm improvement anyway. However, there is no denying the psychological importance of actual job growth and a small positive on job growth could give a major lift to consumer, business, and investor confidence. If this transpires, the investment themes of much of 2009 should roll over into 2010, with still rising stock prices and higher long-term interest rates.
CONSUMER FINANCES—LOOKING UP, From Alan Levenson, chief economist, T.Rowe Price
Real personal consumption expenditures (PCE) rose 0.2% in November, the sixth gain in seven months, and are on track for 1.8% annualized growth in Q4 (Q3: +2.8%), which would cap the strongest two-quarter performance in almost three years. While the growth rates are modest, firming consumer underpinnings are eroding risks of renewed retrenchment.
• Tax relief lifted purchasing power in the early months of the spending recovery, but an improving labor income profile—reflecting waning employment contraction and continued modest growth in weekly earnings—is offering lasting support that will only gain strength as the labor market trends continue to improve.
• The personal saving rate in November held October’s upward revised 4.7% posting, a level that is facilitating meaningful balance sheet repair. “Saving” has been allocated not only to the purchase of financial assets, but also to the retirement of outstanding debt. As a result, household debt service (principal & interest payments on mortgage and consumer obligations) fell to an eight-year low of 12.85% of disposable income in the third quarter (Q2: 13.05%), releasing cash flow to fund new consumer purchases. Declining non-mortgage credit balances and interest payments (1.9% of disposable income in October-November vs. 2.0% in Q3) offer high-frequency indication that household debt service continued to decline into year-end.
These observations are not meant to hint at mounting upside risks to the growth outlook. Indeed, we continue to expect the pace of recovery from the deep 2008-2009 recession to be restrained by a further rise in the personal saving rate toward 6% over the course of 2010, which would reduce spending one-for-one relative to income growth; a muted residential construction rebound beneath an overhang of vacant properties; and a business investment cycle tempered by a focus on reducing accumulated debt stocks. At the same time, however, the increasing solidity of cyclical underpinnings surely has reduced the probability of downside risk scenarios that were a clear and present danger just six months ago.
LOOKING BACK AT 2009—AND THE DECADE, From Ron Surz, president, PPCA
Returns in 2009 were good, but it was one of only three good years in the past decade. U.S investors broke even on average during this decrepit decade, unless you were concentrated in the growth stock segment of the market, where most losses occurred. Even though growth outperformed value in 2009, it underperformed for the full decade, losing 8% per year while value stocks grew at 7% per year. This will make it difficult for growth stock managers to retain business because investors routinely confuse style with skill, and academics assert intrinsic superiority to value investing.
It wasn't that long ago that growth stock managers benefited from investors’ style-skill dyslexia as the growth bubble inflated. What goes around comes around. Do not confuse style with skill; custom benchmarks can help. Style rotation is a separate and distinct decision from the active-passive decision.
Diversifying outside the U.S. has helped, with every country except Japan outperforming the U.S. in the past decade. Some will say diversification has “worked” because exposure to foreign markets improved returns, but that is not the promise of diversification. In theory, diversification improves the reward per unit of risk—it smoothes out the ride.
REPORTS CALENDAR
Monday, January 4:
ISM Manufacturing Index (December);
Construction Spending (November).
Tuesday, January 5:
Factory Orders (November);
Pending Home Sales (November);
Automobile Sales (December).
Wednesday, January 6:
ADP Employment Report (December);
ISM Service Index (December);
FOMC Meeting Minutes;
Corporate Earnings: Bed Bath & Beyond, Family Dollar Stores, Monsanto.
Thursday, January 7:
Chain Store Sales (December);
Corporate Earnings: Constellation Brands, Lennar.
