18 Jan 2013 Trends
Note: Our office and markets will be closed on Monday in observance of Martin Luther King Day.
Trends suggest direction, tendency, and strength of forces driving events or conditions we consider important enough to observe and track. As we embark on a new year, perhaps it would be useful to check in on some of the major trends impacting our lives and investments.
Perhaps the most significant and attention-absorbing trend for the past four years has been that of the rapidly growing US debt. Our debt has increased by over a trillion dollars each of the last four years. Debt and deficits dominated the presidential race and continue to hold government in gridlock as the ideological divide between more and less government deepens and widens.
It is not entirely accurate to simply say that growing government is the problem. A look at the chart below reveals that two vital parts of government spending; defense (in red) and non-defense (in blue) have actually declined or remained steady since 1960, as related to gross domestic product of the United States.
Moreover, it is entitlement ‘transfers’ and interest on debt (in bold black) that have trended up at a steady and powerful rate. In 1960 transfer payments represented less than 7.5% of GDP. They now represent just over 20%. Transfer payments are those that take money from the pocket of one and ‘transfers’ it to another. In the case of interest – money is transferred from taxpayers to US Treasury bondholders. In the case of Social Security – from workers to retirees or young to old and so on. Nothing is created or produced in the transfer, so these amounts are isolated in the reporting of GDP, and until recently largely ignored by the population and policymakers.
The dilemma of mounting debts caused by growing entitlements has become not only a political issue, but an economic one. It is a primary reason our economy has not been able to snap back from recession as quickly as from past recessions since WWII.
As stated earlier, transfer payments or entitlements are not productive; in fact the taxes required to pay for them drain resources from the productive engine of the economy – the private sector. As entitlements grow, the free-market economy, i.e. the engine pulling the ‘entitled,’ is increasingly burdened by a heavier load with diminishing fuel supply (capital) and pulling power (the will to do so).
Fed Chair Ben Bernanke said on Monday that he expects a lot of debate in coming months about the size of government. He also said he hoped that Congress would raise the debt ceiling in course as it does not increase government spending but only allows the federal government to pay the bills already incurred. In a hat tip to the majority party, he also indicated that government spending reflects the values and will of the public.
The most watched barometer of the investor opinion is the stock market. It’s trends suggest no real concerns, at least in the short to medium term, allowing for a potential bump around debt ceiling talks. The US stock market as measured by the Dow Jones Wilshire 5000 is up 5.6% since the end of December when many were convinced we were going over the fiscal cliff. Since the deep market trough of the Great Recession on March 3, 2009, the Wilshire 5000 (we use VTI to track this index) is up a whopping 128%.
The bond market is credited as being the wiser and longer looking trend-watcher of the two markets, with highly liquid US Treasury market being the most sensitive. Falling bond yields are traditionally indicative of a slowing economy, one in which inflation is not expected to be a problem for a long while. In the chart below you can see that the yield trend since March of 2009 (the stock market trough of the Great Recession) has been declining pretty steadily from a peak of 3.9% in April 2010 to a current 1.83%.
Whether one attributes record low bond rates or yields to bondholder’s poor outlook for economic growth or unprecedented Fed actions, or a combination of the two, really doesn’t matter. Today’s low rates are not indicative of a healthy and growing economy.
Economists polled by Bloomberg expect Treasury yields to decline further (our IEF would rise in value) during the first six months of 2013 as the reality of slowing growth and
budget problems creep back into focus. As a result, the 10-year yield may decline toward 1.60%, the lowest level since September.
The World Bank’s full-year GDP growth forecast for the US in 2013 is 1.9%, just above the 2.0% median of the 96 forecasts in the Bloomberg survey. The Fed’s central tendency is considerably higher: 2.3 to 3.0%, with 2.0% considered an outlier.
Any of these estimates fall below the historical potential of the US economy. Real GDP has grown an average of 3.2% per year since 1947. At this level of growth, jobs are created and the potential increases for improvement in innovation, productivity, and living standards. Current economic trends are improving, but do not yet indicate the strength needed to boost our economy to levels approaching 3% or more.
A growing economy also puts pressure on prices, potentially causing inflation. So far inflation trends suggest no threats in the near future. Inflation measured at the producer’s level remains muted as the Producer Price Index (PPI) dipped 0.2% in December and 0.8% in November. Energy, food, and capital goods prices all declined to lower the threat of producer inflation.
At the consumer or household level, where we live, prices moderated, particularly those of energy with natural gas falling to new lows. The Consumer Price Index or the CPI was unchanged in December after dropping 0.3% in November.
But the intermediate-term question is what will happen to inflation given the Fed’s extraordinarily expansion of monetary policy? Milton Friedman taught that: “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” As a big fan of Milton Friedman, I must agree, but his observations take place over longer periods of time than a few years.
The Fed’s extraordinary actions of the past couple of years have likely not caused inflation because workers, capital, stores, factories, and offices remain idle or under-utilized. So far there is little evidence that inflation is trending.
Housing is becoming the more important to the expansion as it recovers from its depression. December’s housing starts rebounded a sharp 12.1%, following a dip of 4.3% the month before. The new home market took a breather in December, but had been rising dramatically in the eight months prior. The index now stands at 47, just three points shy of the 50 level, which would indicate that more builders describe conditions as good than bad.
The industrial sectors of our economy, the unquestioned heroes of the current recovery, continue to pull more than their share. The Fed’s Beige Book which summarizes trends in all of the Federal Reserve’s 12 Districts characterized the pace of growth as either modest or moderate. The prior Beige Book emphasized growth “at a measured pace.”
The consumer is the real driver of the US economy, representing over 70% of GDP. All twelve districts reported some growth in consumer spending. Overall, holiday sales were reported as being modestly higher than in 2011, though sales were below expectations for contacts in many of the Districts, according to Econoday.
Unfortunately the cliff and continued policy uncertainty from Washington have taken a toll on consumer confidence and willingness to spend. The government reported today that the Consumer Comfort Index lost 3.7 points from its recent high two weeks ago, dropping to minus 35.5 on its scale of minus 100 to plus 100. This level represents the weakest since October 7th according to Econoday.
In reflection of the continuing difficult job market, fiscal uncertainty, and weak economy overall, sustaining improvement in consumer confidence remains a challenge. The report showed that 36% of Americans now say the national economy is getting worse, versus 29% who say it is getting better. After reaching a 10-year high in November, “getting better” sentiment has lost 8 points in two months, according to Econoday. Just 28% call it a good time to buy things, the fewest since late September and below 30% for only the third time in that period. Only 20% or consumers polled rate the US economy positively.
Today’s trends shape tomorrow’s reality. Trends represent the sum of decisions and actions of all those people or factors represented in a measureable movement. In that sense, our future is shaped and determined by the choices we make or others make for us today. As far as government goes, we have cast our votes for president, congressmen, governors, and all the rest, and so delegated much of the direction of government to their judgment for the next two and four years.
Recognizing then that we have little to no control over the mega trends that impact our lives, it is all the more vital to our future well-being that we take control of the trends in our lives over which we exert significant or complete control; such as risk, savings, giving, spending, taxes and expenses. Only by controlling and re-directing these trends can we shape a richer and more abundant future for ourselves and those who follow. Don’t waste your time and energy on trends beyond your control.
Rather take greater control of your life than you ever imagined possible. Invest your time, resources, talent – invest yourself in a trend of your own designing and planning aimed at becoming the best you can be. We are here to help you, it’s what we do.