24 Jun 2011 Bumping Along the Bottom
The US economy grew at 1.8% in the first quarter according to the Commerce Department’s second and unrevised estimate. Following their monthly meeting, the Federal Reserve said they still expected the economy to recover, but reduced their 2011 GDP growth estimates from 3.3% – 3.7% to 2.7% – 2.9%. They forecasted growth of 3.5% – 4.2% in 2013. Forward looking stock investors have taken the S&P 500 down 5.9% from its April 29th high, but the index remains up 3% for the year. Bonds on the other hand have done well as the economy slumps. The Barclay’s 7-10-year Treasury index is up 5.5%.
The economy as measured by Gross Domestic Product is considerably off from its 3.1% pace in the fourth quarter and the prospect for improvement soon has been diminished by more recent data. Durable goods orders fell 3.6% in April, after a 4.6% jump in March. Excluding transportation (which tends to be lumpy), new orders slipped a revised 1.6%, as compared to a 2.6% increase in March. Weakness was widespread across industries. But recent regional Fed manufacturing surveys have suggested a more positive tone. New orders indexes for ISM and Philly Fed were modestly above breakeven according to Bloomberg and the Empire State (NY Fed) index remained moderately high in positive territory.
The Federal Reserve left policy rates unchanged (0 – .25%) this week and will allow QE2 ($600 billion purchase of US Treasuries) to end this month. However, they will delay the unwinding of their swollen asset portfolio, meaning, for the time being, that they will purchase new bonds to replace those that naturally mature. The Fed believes the current sluggishness in the economy is temporary. And remarkably, they see the recent rise in inflation as transitory. After food and energy prices relax, they see inflation falling below their implicit target. Also noteworthy is that the Fed seems considerably more sanguine on the economy than most economists as they seem to be placing most of the blame for the slowdown on the supply disruptions from Japan.
Another notable observation from the Fed was their prediction that unemployment would average between 8.6% – 8.9% in the fourth quarter of this year compared to an April forecast of 8.4% – 8.7%. During his press conference following the meeting statement, Bernanke suggested that the Fed’s ability to do more was waning. He said that they had already “done extraordinary things” to spur growth and that additional stimulus might fuel inflation.
The jobless report for the week of June 18th showed a 9,000 rise in initial claims pushing the total to a higher-than-expected 429,000. This level is 15,000 higher than the May 14th week.
There’s little initial reaction but this report won’t be a positive for today’s financial markets. Initial claims have stubbornly remained above 400,000 for 11 straight weeks.
Just as unemployment resists improvement, so does the housing market. Existing home sales fell 3.8% in May to a 4.81 million annual rate. The annual rate fell to a negative 15.3% from April’s negative 13.8%. Supply at 3.72 million is falling but not fast enough to match the decline in sales. Supply rose to 9.3 months vs. April’s 9.0 months. New home sales weren’t much better as they fell 2.1% in May to a 319,000. Supply in terms of months dipped slightly to 6.2 months from 6.3 in April and from 6.9 in March. But in a good sign for prices, supply in terms of the number of homes on the marked dropped 6,000 homes to 166,000. That total has never been lower in nearly 50 years of data, according to Bloomberg.
Prices for new homes may be firming. They rose 2.6% to a median $222,600 and the average increased 0.5% to $266,400. Prices for existing homes rose 3.4% to a median $166,500 and up 2.0% for the average to $214,400. But the heavy supply doesn’t point to much pricing power in the near future. The Federal Housing Finance Agency also reported an April increase in prices which broke a six-month string of monthly declines. The FHFA purchase only house price index rose 0.8% in April, following a 0.4% decrease in March.
The most visible and closely followed opinion poll is the US stock market. While still up for the year, it has taken a nearly 6% dip in the past couple of months. Individual investors pulled $7.33 billion from long-term US and foreign stock funds last week and $5.76 billion the week before according to ICI. It was the second straight weekly outflows ICI reported after a 21-week streak of gains that added nearly $122 billion on an unrevised basis. As they left equities, individual investors voted for the relative safety of bond funds which saw inflows of $2.49 billion last week and $5.53 billion the week before.
Questions about sovereign debt such as that of Greece continued to put pressure on money market funds as well. iMoneyNet reported that money-market funds slumped $27.5 billion to a total of $2.679 trillion in the week ended Tuesday. Seven-day yields for taxable money-market funds held steady at a record and paltry low of 0.02% for the 12th straight week. By comparison the dividend yield of the S&P 500 is 1.83%. The dividend yield on our Vanguard Total stock Market ETF is 1.7%. The yield on our 7-10 year Treasury index ETF is 3%. With inflation near 2%, the capital markets, not money markets look like the best place for your money.
Thursday, House Majority Leader Eric Cantor and fellow Republicans pulled out of bipartisan budget talks headed by Vice President Joe Biden saying they had reached an impasse over taxes that only President Barack Obama and Speaker John Boehner could resolve. But he remained optimistic about the prospects for a deal according to statements in the Wall Street Journal. He said the Biden group had already made significant progress and had tentatively identified more than $2 trillion in spending cuts over the next 10 years. He reiterated there could be no agreement on an overall package without breaking the impasse between Republicans’ refusal to accept any tax increase, and Democrats insistence that some tax hikes be part of the deal.
We continue to believe that the most significant measure from Washington for getting this economy going is for employers to know how the government will grapple with the huge deficits, entitlements, and debt. Understanding the burdens that will be placed on them in the years ahead in taxes, payroll benefits, and regulations enables them to make more informed and confident hiring decisions. If the emerging markets continue growing without major disruptions, then maybe just maybe, they’ll provide enough fire-in-the-belly of American businesses to revive not just ours, but the rest of the world’s economy like we used to in the good ole days.
Have a nice weekend.