The Fed Considers, From David Kelly, chief market strategist, JPMorgan Funds
On Tuesday the Federal Reserve’s Open Market Committee holds its second meeting of the year to consider the direction of monetary policy. They will not lack for advice on what to do. However, the best advice is probably to do nothing, at least on the overall stance of monetary policy.
Data released last week was heartening as it showed that, despite foul winter weather, economic activity is continuing to grow in the first quarter of the year. In particular, the retail sales report suggests that real consumer spending is climbing at a better than 3% annualized rate. This increased demand—combined with better weather, pent-up demand for consumer durables, and signs that the economy is now in net job creation mode—provides some assurance that the economic recovery is gaining a stronger footing, something the FOMC will likely to allude to in its post-meeting statement.
At the same time, some numbers this week will emphasize just how far we are from a normally functioning economy. Industrial production appears to have seen very lackluster growth in February, while housing starts, at 600,000 units, remain about one million units below the long-term rate suggested by our demographics. Weekly unemployment claims also are proving to be stubbornly slow in falling, and may remain above 450,000 in the numbers due out on Thursday. Meanwhile, the index of leading economic indicators for February, while expected to post its 11th straight gain, should rise by just 0.2%, consistent with only a modestly growing economy.
In this environment, the dangers of an economic relapse and a descent into deflation are markedly greater than the risk of inflation, both in probability and in consequences. For this reason, and because of the need to further boost bank capital and bank lending, the Federal Reserve is likely to re-emphasize its intention to maintain exceptionally low levels of the federal funds rate for, in their words, “an extended period”.
A persistent risk facing investors is that an unwise tilt in monetary or fiscal policy disrupts the economy. Hopefully, this week the Federal Reserve will provide reassurance that, at least for its part, it has no intention of making such a mistake.
SLOW GROWTH, BUT IT’S GROWTH, From Bob Doll, vice chairman and chief equity strategist, BlackRock
On Friday, U.S. retail sales for February were reported to have grown at a 0.3% rate (0.8% ex-autos), suggesting that the severe winter storms will not have had as significant an impact on consumption as many feared. From our vantage point, it appears that real consumer spending will advance more than 3% in the first quarter. Among other positive news reported last week, tax revenues for February showed the first year-over-year increase since April 2008, largely due to an increase in corporate tax receipts.
We have been saying for some time that we expect the economy to be in a subpar recovery mode. Such a scenario, however, does not mean that the cyclical bull market needs to come to a close. As last week’s data shows, there is still room for positive economic surprises. Likewise, we believe there remains ample upside potential for corporate profits over the coming months and quarters. The main risk to markets, in our view, is the possibility of the economic recovery failing to become self-sustaining. The key variable, of course, is the employment picture.
With jobs still being lost on a monthly basis, it is understandable that pessimism and cynicism about the state of the economy continues to run strong. Most observers rightly believe that employment gains will need to occur before a self-reinforcing mechanism is in place to drive the economy. In our view, strong corporate balance sheets, improving profit margins and increases in business confidence mean that companies should ramp up their hiring efforts soon. Once positive employment conditions begin to clearly emerge, we expect the debate will shift to the path of Federal Reserve policy.
Looking ahead, we believe economic growth should continue to improve, which should provide a boost to investor confidence. Additionally, merger and acquisition activity has picked up strongly in recent weeks, as have corporate share buybacks, trends that help promote an equity-friendly environment. On balance, we continue to expect equity markets to endure ongoing periods of volatility, but reaffirm our belief that the cyclical bull market has further to run.
WHY WE’VE GOT NATURAL GAS, From Malcolm Gissen, co-manager, Encompass Fund
Contrary to popular perception, the U.S. has enough natural gas to make us entirely energy self-sufficient when it comes to producing electric power. And with electric cars becoming a viable means of future transportation, U.S. natural gas resources could free us from importing oil from the Arab World and Venezuela.
Natural gas produces only a fraction of the nitrogen oxide and carbon dioxide emissions produced by burning coal and oil and with none of the accompanying particulate matter or sulfur oxide. As a result, more than 50% of new power plants built in the U.S. since the 1980s have been natural gas plants. Still, because coal is cheaper and in plentiful supply, more than half of America’s electricity currently comes from coal-driven plants. That trend will likely reverse due to environmental concerns and an emphasis on clean technologies, promising to fuel the expansion of natural gas plants. And consider this: Technological advancements in natural gas exploration, especially in the shale plays, have made it possible to extract far more natural gas from the ground than petroleum engineers dreamed possible even 10 years ago.
As with any process that extracts something from the ground, there are environmental concerns. The industry assures us that they are concerned about the environment and have the technology to assure minimal environmental impact. Certainly federal and state environmental protection agencies are aware of the concerns, are judicious in granting permits, and are monitoring these operations.
We believe that in the long-term, demand for natural gas will increase significantly with an accompanying rise in price. While the current price is not inexpensive, with an improving economy, continued growth in the Third World and an emphasis on cleaner energy, investors are likely to benefit from exposure to natural gas.
WATCH FOR THE DOUBLE DIP, From David Rosenberg, chief economist and strategist, Gluskin Sheff
The smoothed ECRI leading economic index for the U.S. fell last week for the 12th week in a row, to stand at its lowest level since July 2009. Something tells us a slowdown is about to start.
We marveled at the 5.9% annual rate real GDP growth performance in Q4, though it should not be lost on anyone that nearly all the growth came in two non-recurring items — inventories and capital spending (the former is a temporary alignment of stocks with sales and the latter is a late-year rush to take advantage of some tax goodies). The rest of the economy actually slowed to less than a 1% annual rate last quarter. This is actually encouraging to those who see a big slowdown coming, or even a double dip.
We looked the 60-year history of quarterly GDP data and broke the numbers into two subsets. The first set included business expansions that lasted more than 12 quarters (1961-1969, 1975-1979, 1983-1990, 1991-2000, 2001-2007). The second included expansions that were 12 quarters or less (1950-1953, 1954-1957, 1958-1960, 1971-1973, 1980-1981). The results are quite different.
If we expect to undergo another long economic expansion (average: 30 quarters) then we are not likely to see the peak in growth until the 13th quarter, when, on average, real GDP was running at a 7% annual rate. But if this turns out to be a short economic expansion (12 quarters or less) then the peak in growth happens in the first and second quarter of expansion. And that is exactly what seems to have happened this time around.
In other words, when the quarterly peak in growth happens this early — the second quarter of expansion this time around — then it usually signals a high chance of this being a truncated expansion; and we are seeing signs of this in the ECRI leading index too. This all augurs quite well for defensive, not cyclical strategies and buying insurance right now to protect any long portfolios is dirt cheap with the VIX index sitting at 17.
WATCH OUT FOR MUNI TRAPS, From Marilyn Cohen, president, Envision Capital Management
What’s the difference between Greece and California? For now, California doesn’t have the riots seen in Greece. California’s economy is larger and our debt burden is less but out unfunded debt is humongous. The woeful state of the States, as a current Barron’s article tells it, is mostly self-inflicted.
Whose budget gaps follow in California’s wake?
New York 30%
New Jersey 29%
You know the problems and reasons for the problems, so let’s discuss the investments that circumvent them. First, buy Tennessee State General Obligation Bonds. The Center on Budget and Policy Priorities projects Tennessee’s fiscal 2010 budget gap to be $1 billion. Not pleasant, but certainly manageable.
Although Alaska faces a $1.3 billion budget gap for 2010, it is not as terminal a deficit as other states must deal with. Alaska’s cash reserves are plump—$10 billion, to be exact. If push comes to shove and economic/oil prices take longer to rebound, Alaska can wait it out. The State won’t have to borrow or hijack its children’s financial future.
An excellent source for studying the various state budget gaps is to Google your state followed by “budget gap.” There, you’ll find the report with an easy grid of state projections, size of the gap and its percent of the general fund budget.
For now, stick with good quality state and city General Obligation bonds. The credit crisis should have taught all of us that anything can happen.
Dollar Bulls Beware, From Peter Schiff, Euro Pacific Capital
The market is now perfectly positioned for a massive dollar sell-off. The fundamentals for the dollar in 2010 are so much worse than they were in 2008 that it is hard to imagine a reason for people to keep buying once a modicum of political and monetary stability can be restored in Europe. In fact, the euro has recently stabilized.
My gut is that the sell-off will be sharp and swift. Once the dollar decisively breaks below last year's lows, many of the traders who jumped ship in the recent rally will look to re-establish their positions. This will accelerate the dollar's descent and refocus everyone's attention back on the financial train wreck unfolding in the United States.
Any doubts about the future of the U.S. dollar should be laid to rest by Friday’s announcement that San Francisco Federal Reserve President Janet Yellen has been nominated to be Vice Chair of the Fed's Board of Governors, and thereby a voter on the interest rate-setting, seven-member Open Markets Committee. Ms. Yellen has earned a reputation for being one of the biggest inflation doves among the Fed's top players.
It is not surprising that President Obama made this selection. Yellen has consistently downplayed the dangers of inflation and has made statements that indicate she views the Fed as an extension of the Labor Department, rather than a guardian of our currency. Last month, in discussing what she saw as the Fed's obligation to promote employment, she said, "If it were possible to take interest rates into negative territory, I would be voting for that." She may very well make Chairman Bernanke look like a tightwad by comparison.
It is anyone's guess which sparks will be responsible for igniting the falling dollar powder keg. From a trader's perspective, a sharp reversal in the dollar will catch many investors completely off guard. Those who stepped off the short-dollar train will be stuck on the platform as it speeds away. Those who refused to give up their seats are in for a hell of a ride.
REPORTS OF THE WEEK
Monday, March 15: Industrial production (February), Nat’l Assn of Home Builders Housing Index (March)
Tuesday, March 16: Fed Open Market Committee Announcement, Import prices (February), housing starts (February)
Corporate Earnings: Ambac Financial, Discover Financial
Wednesday, March 17: Producer Price Index (February), Mortgage Applications (weekly)
Corporate Earnings: Nike
Thursday, March 18: Leading Economic Indicators (February), Fed Balance Sheet (weekly), Jobless claims (weekly)
Corporate Earnings: FedEx, Palm
Friday, March 19: Quadruple witching day
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