10 Dec 2010 Recovery May Get A Better Boost from Washington This Time
The biggest news this week was that of the deal reached between President Obama and Congressional Republicans on extending the Bush tax cuts. On the news, the S&P surged two thirds of a percent then settled back as investors considered both the potential for higher deficits, at least in the short run, and the difficulty of getting it through Congress as liberal Democrats railed against the measure throughout the day. Obama defended his deal saying he was able to preserve tax breaks for the middle-class and extend unemployment benefits that were set to expire.
The tax cuts combined with measures designed to stimulate investment in equipments, plants, and research are coming at a good time. The Federal Reserve reported yesterday that as of the end of September, non-financial companies in the US are sitting on $1.93 trillion in cash and other liquid assets, or 7.4% of the companies’ total assets—the largest share since 1959.
Company management remains extremely cautious about investing in the face of anemic economic recovery, dangerously high unemployment, and embattled household finances which continue to limit consumers’ spending. The compromise between Republicans and the White House addresses both sides of the equation with tax cuts to potentially stimulate investing and hiring from small businesses to large along with a 13- month extension of unemployment aid for the long-term jobless and a one-year cut in payroll taxes for all who are employed. The next few days will determine just how far entrenched Democrats are willing to push their politics.
Good news continues for US manufacturing as the nation’s trade deficit shrank more than forecast in October on a weaker dollar and growing economies overseas. The gap narrowed 13% to $38.7 billion, less than the lowest estimate of 78 economists surveyed by Bloomberg News and the smallest since January 2010. Exports were the strongest since August 2008 as Mexico and China bought record amounts of US products. Exports increased 3.2% to $158.7 billion, boosted by sales of foods, automobiles, engines and industrial supplies like fuel oil and natural gas according to the Commerce Department.
The dollar is down 6.6% from its June 7th high against a trade-weighted basket of currencies. The drop makes American goods cheaper to buyers abroad and helps promote the expansion of US manufacturing for the 16th consecutive month in November. China has complained bitterly recently saying the Federal Reserve manipulates the world’s currency unfairly to promote American exports. Hmmm, could the pot be calling the kettle black? At any rate, Fed measures to stimulate the US economy by pouring in an additional $600 billion in cash through their Treasury buy back do indeed have the beneficial effect of making American goods cheaper abroad. The downside is that it makes foreign goods more expensive. A separate report showed the cost of goods imported into the US rose in November by the most in a year, led by gains in commodity prices such as fuels, agriculture products and metals.
The US trade gap with China shrank to $25.5 billion from $27.8 billion. But that progress is not fast enough for Administration, Congressional and business leaders. They accuse China of keeping its currency too low in order to boost sales overseas. The renminbi’s advance of 0.1% last month and 0.3% in October fell well short of the 1.7% climb in September that Treasury Secretary Timothy F. Geithner signaled was appropriate. China today reported a monthly trade surplus of $22.9 trillion for November, exceeding the median forecast in a Bloomberg News survey. China today reported a monthly trade surplus of $22.9 trillion for November.
Consumer confidence continues from the post Thanksgiving period. The consumer sentiment index came in at 74.2 compared to a 71.6 reading in November. Another positive was that price increases underway for gasoline and food have yet to affect inflation expectations which actually slipped one tenth both for one-year expectations, now at 2.9%, and for five-year expectations at 2.7%. Improvements in the stock market and falling jobless claims are improving consumer sentiment.
For now, improving confidence is translating into better retail sales. The Fed’s Redbook same-store sales index rose at a 3.8% annual pace in the December 4th week, much higher than trend yet below the 4.9% Black Friday surge of the prior week. Month-to-month, Redbook reports a very solid plus 0.6% pace that offers an early signal of strength for the ex-auto ex-gas category of the December retail sales report. Redbook says heavy storms in the Midwest and Northeast kept shoppers at home and made for a boost in online sales.
Wholesale inventories rose 1.9% in October, below the 2.2% surge in sales at the wholesale level. Very early indications on inventories hint at a build for the fourth quarter and given strength in retail sales, it represents potential for jobs growth.
As the economy shows signs of new life, stocks are rising and Treasuries are falling. Treasuries are under pressure on two fronts; potential inflation and re-allocation (investors moving from bonds to stocks). The unusual financial catastrophes of late 2007 sent trillions of dollars into the Treasury market forcing prices and sending yields to historical lows. Now that the economy is showing signs of improvement, some of the ‘fast’ money is coming out of Treasuries and into gold, commodities and stocks.
Treasuries have dropped precipitously of late, sending yields up more than 1% at longer maturities. The reason is largely due to the movement of speculative or ‘fast’ money in anticipation of inflation or in hopes of finding better returns in other asset classes. But ‘fast’ money does not necessary imply ‘smart’ money.
The 7-10 year Treasury index in our models is down roughly 6.6% from its peak in October. The last big drop in this index occurred in the span from December ‘08 to June ’09. The index dropped 12% then, but quickly regained half of its value by October of ’09, Another powerful upsurge began in April of this year taking the index up 13.6%. Point is, even Treasuries, traditionally a haven for the risk averse, have become been added to the volatile playground of the ‘fast money’ movers. ETF’s have made it vastly easier for them to do so.
But as a passive investor in the 7-10 year Treasury index you needn’t be overly concerned with their daily and monthly gyrations. The weighted average coupon of this pool is 3.76% and it and the ultimate repayment of face value are both guaranteed by the full faith and credit of the US government. Those steady coupons and the promise of getting your principle investment back within 7-10 years significantly offset any temporary price deterioration. Another fact is that inflation simply does not appear to be in the cards any time soon, especially with the significant drag of real estate and unemployment.
Then there’s history; the 7-10 year Treasury index has never fallen more than 9.5% in a 12-month period in the past 75 years. And finally, the Treasury component of your portfolio is just that – one component. As Treasuries fall in value on anticipation of an improving economy, stocks rise in value on anticipation of an improving economy. Our Risk Averse portfolio contains a 60% allocation of 7-10 Year Treasuries and is still up 8% year-to-date, despite the 6.6% drop in the 60% component.
Diversification and situation-specific asset allocation are a considerably smarter approach to lifetime investing than chasing the ‘fast money’ herd. Have a nice weekend.