2011May31 Markets; Inflation & Debt
Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble . . . to give way to hope, fear and greed.~ Benjamin Graham
There has been a downshift in economic growth lately that has caused markets of all types to gyrate. Commodities moved sharply lower before rebounding modestly; Treasury yields have moved even lower; the dollar has shown some strength; and stocks have been more volatile, but have still moved in a roughly sideways fashion. While disconcerting, this type of action is to be expected as some of the "dollar carry trades" unwind and investors adjust to a slower growth phase.
Regional manufacturing surveys dropped sharply last month, although they are notoriously volatile and mostly remained in expansion territory. Industrial production was flat in April, versus expectations of a gain of 0.4%, while capacity utilization fell 0.1%, and remains 3.5% below the 1972-2010 average. These indications of a slowdown in growth has been confirmed by Treasury yields moving lower, indicating growth concerns trump inflation. It is a bit surprising that investors continue to loan to companies and the government at such low rates; locking in a low return if held to maturity and the potential for somewhat worse results if rates start to move higher.
It's easy to get mired in the disappointing. Growth has indeed slowed and concerns are justified, but the majority of indicators still indicate economic expansion. Additionally, there have been several external factors we believe have impacted data temporarily. The Japanese natural disasters disrupted supply chains that are starting to come back online, while extreme weather impacted production and distribution in the United States. Further, the spike in oil prices above $110 per barrel seemed to have a large effect on sentiment among businesses but we have seen that improve with the recent weaker oil price. And while the Index of Leading Economic Indicators fell 0.3% in April, it was only the second negative monthly reading since March of 2009, and we believe it will resume its positive trend in May as some of these temporary factors dissipate.
Raising the country's debt ceiling continues generating political debate and intermittent market concerns. Unlike many political games of bluff, the "deadline" is relatively close considering Congress' scheduled vacations only leave four working weeks between now and August 2nd. Restraining spending is the major standoff separating the House from the Senate and the Administration. Public support for not raising the ceiling has increased to almost 50% of the population. When investigative reporters for foreign media uncover $2 Billion in spending on nude parties, Jell-O wrestling matches and treadmills to strengthen hearts of shrimp, it is difficult to believe the budget can't be cut. (The $2 Billion was spent by one agency, the National Science Foundation). If you think there just might be a bit more wasted tax money, you can start looking for it here.
Reduced government spending does come with an economic price. For one, it will increase the unemployment rate and the affected departments and staff will certainly object. Stephanie Kelton, Ph.D. has clearly illustrated with a teeter totter the household impact of changes in government spending.
The government's reporting of inflation is often frustrating since the volatile prices of energy and food are omitted from the core rate. Housing, however, is included. Even homes without mortgages are included as having an "equivalent rent" value. The rising number of foreclosed homeowners has placed unusual pressure on rents. Residential rents are part of the core inflation calculation are likely to exert more impact than gasoline at $4.
At this point, an improved jobs picture seems to be the only thing that may help the struggling housing market. Housing starts were down 10.6% in April; permits were down 4.0%; and existing home sales were down 0.8%--all confirming the year-over-year median price drop we saw in existing homes as foreclosures and other distressed sales continue to plague the market. The silver lining is that mortgage rates remain extremely low, pricing is more attractive, and the impact on the US economy of housing has dropped substantially. We continue to believe the healing of the housing market is going to be a multi-year process, but a more rapid improvement in job growth would likely accelerate that development.