Market Insights: January 21, 2014
Economic Outlook: Understanding the math of jobs…
- We commented last week that we do not believe the U.S. recovery is close to running out of gas. This past week, the Johnson Redbook Survey of chain stores posted a 3.5% year-over-year increase in the first January report. David Rosenberg of Gluskin Shelf Research pointed out that the Citibank Economic Surprise Diffusion Index is now at a level north of 70, suggesting that the U.S. economy is closer to “escape velocity” than at any time since 2009.
- The U.S. retail sales report for December could be characterized as “mediocre” on a monthly basis: +0.2%. Looking under the hood however, there are some interesting things to note. Discretionary spending on eating out is up a strong 5% from the year-earlier number. This is an important barometer on consumer sentiment about spending money.
- We commented several weeks ago on increasing optimism by corporate CFOs. The Small Business Index from NFIB closed the year at 93.9, up from November. Job creation among NFIB firms was the best since February, 2006. Reports of capital spending rose significantly in December to a level 9 points above November, and plans to make expenditures rose also. This is an important confirmation on the direction of sentiment from the small business community.
- The improving economy is helping government tax collections at both the federal and state level. The federal government’s deficit for October – December declined by more than 40% from the level of the previous year. In addition, as we commented last week, state budgets are improving, thanks to austerity combined with better tax receipts. Even California is projecting to run a surplus this year.
- After the disappointing jobs report of a week-ago last Friday (+74,000 new jobs), the unemployment rate stands at 6.7%. While this is close to the 6.5% benchmark that a number of Fed Governors have spoken about, the underlying data still evidences the slow and incomplete economic recovery. The number of long-term unemployed (+27 weeks) remains stuck at about 3 million. And almost 8 million people are working part-time, but would like to be working full time. We are not out of the woods yet on jobs.
- We continue to believe that weak jobs report might be a data blip, since it is inconsistent with other data releases, like the ADP Report of the same week. Even the Department of Labor noted that weather-related issues likely affected the number.
Equities Outlook: Is there an opportunity here?
- We’ve commented consistently for several months that while the outlook for equities remains positive, a correction could occur anytime. Clients ask, “What’s the trigger?” It is difficult to say but could be almost anything that escalates fear.
- Here’s one example from James Paulsen, Chief Strategist with Wells Capital Management. We may see in 2014 the initial shift to fear that the economy might be in danger of overheating. We have a new Fed chairman (widely perceived as a Dove), a relatively weak dollar, rates close to zero, some tightening in the resource market (CRB Raw Industrial Materials index up 5% since last October), unemployment down close to 6.5%, factory utilization rates hitting 80%. All of these suggest we are witnessing a synchronized global recovery. This could change the conversation and might become a trigger.
- Nonetheless, to reiterate, we are talking a correction (of the 10% variety) not a bear market slide (of the 20%+ variety).
- We wrote last week about a steeper yield curve favoring financial names. Last week’s bank earnings releases were below expectation, disappointing traders. However, the setting for these companies in a longer-term context looks good. Their cost of funds is virtually zero. The companies are revising their reserves and are very liquid. Most have cut their base of expenses. In a slowly recovering economy, banks are positioned for great opportunities to increase earnings.
- Homebuilders, materials suppliers, and related sectors will benefit if the housing demand from first-time homebuyers picks up. Some important data points suggest this could be in our near-term future. The number of 25-34 year-olds who are employed has now recovered to where it was in 2007. And this, at a time when the home ownership rate for those under age 35 is at the lowest level since the early 1990’s. In addition, household formations are in an uptrend. All of these bode well for this sector going forward.
- Margie Patel, a portfolio manager we respect at Wells Capital Management who specializes in income portfolios for individual investors made a pretty amazing statement about the outlook for equities last week on Bloomberg Surveillance: “If you step back and look at the big picture, it’s really probably the best period we have seen in our investment careers to be an investor in the next three to five years in the U.S.”
- Some suggest that income-oriented equity themes are out of favor. However, note that the simplistic “Dogs of the Dow” strategy out-performed a strong equity market in 2013, even though rates were rising most of the year. We should not forget when talking dividends and cash flow that there is an underpinning of a strong demographic demand for cash flow.
The Fed and Fixed Income Markets: Caution is in order…
- The Ten-Year Treasury spent most of last week very close to the level it closed the previous week. At week’s end, it closed at a yield of 2.82%.
- We wrote last week about the need to keep an eye on indicators of firming inflation in the U.S. That said, we do not believe this is a pressure that represents an imminent threat, mainly due to slack capacity in the global economy. Case in point: the Euro-zone CPI measurement is up only about 0.8% on a year-over-year basis. The European economy has only late last year emerged from a six-quarter recession. While growth has resumed, it is still very tepid. So there is little pressure for inflation in Europe to be exported to other economies like the U.S.
- While the unemployment rate has declined to levels close to the magic 6.5% level (see our comments above), we do not believe the Fed has their finger on any trigger to start tightening policy in the short-term.
- There is widespread agreement that with low inflation pressure, the Fed is unlikely to begin any tightening of policy in the next 18+ months. Soft emerging market economies mean commodity prices are likely to remain constrained. The areas to watch for inflationary pressures will be wages, rents, and services. Anecdotally, one of our Investment Committee members noted that his first haircut of 2014 was re-priced at a 5.5% increase over what he paid in December of last year. That’s considerably above the CPI.
- Though all of this may sound somewhat like a “mixed bag” on the inflation outlook, we remain convinced that caution is in order in constructing clients’ fixed income portfolios and that the principal risk is rising rate pressure and duration risk, rather than credit and default risk.
The Week Ahead – A Quiet One…
- Initial Jobless Claims [U.S.]
- Existing Homes Sales [U.S.]
- Leading Indicators [U.S.]