Daily Bullets……for May 28, 2014

·        Surprise in bonds !........Big story of 2014: bond yields are hitting new lows for the year with 10-year Treasury yield now at 2.44%, a decline in yield of about 20% since the beginning of the year.

What’s the point? The decline in bond yields has surprised investors this year many of whom believed interest rates would rise and were positioned for that. It is important because bonds are a major asset class and bond yields are important determining valuations for financial assets. The reasons for recent the decline in yield include: 1) slow growth in Europe, 2) belief that growth in China is slowing, and 3) increasing belief the ECB will lower interest rates next week. Investors are reacting to the recent news pertaining to global growth and grappling with fully understanding the implications of sustained slower growth. Link: http://money.msn.com/top-stocks/post--treasury-yields-dip-to-new-2014-lows

·        More “limbo”…trading activity reflects economy……Stock and bond market volatility and interest rates are unusually low. This is a reflection of the economic backdrop and is resulting in lower trading profits for investment banks.

What’s the point? As a fundamental shop, we would normally not be all that interested in day-to-day trading activity. What is interesting currently though, is the fact that “fundamentals” are having a noticeable impact on trading volume and volatility primarily because traders are confused about the direction of interest rates and the economy, both of which affect valuation and earnings, the two primary drivers of stock prices. Is this a problem? Sort of, but more importantly, it may be reflecting confusion in the  market over Fed policy, interest rates, the direction of the global economy and inflation, all of which has important implications for the markets and investment strategy. It may also be indicative of what may be lower secular returns on financial assets. Link: http://www.bloomberg.com/news/2014-05-28/goldman-s-cohn-says-inactive-trading-environment-is-abnormal-.html

 

 

 

 

 

Daily Bullets……For May 23, 2014

·         New home sales rise……New home sales rose a healthy 6.4% in April, reflecting normal seasonal improvement but also some snapback from the impact of the very severe winter weather in most of the U.S. Given the recent softness in the housing market, sales of both new and existing homes are down 6.8% from a year ago.

What’s the point?  This is another in a series of recent positive readings for the housing market and has positive implications for the economy. It appears the housing market is beginning to accelerate, some of this, of course, is seasonal. We believe there is pent-up demand for housing based on new household formation; however, tight credit and structural changes in the labor markets have held back the recovery. We believe as employment continues to improve, the housing market should also gradually improve. We also believe there is improving likelihood of changes in bank regulations that could help to improve the housing market over the next year. Link: http://money.msn.com/business-news/article.aspx?feed=AP&date=20140523&id=17646348

·         Food inflation accelerating…..The USDA reported today that severe drought in California could have a lasting impact on fruit, dairy and egg prices, and that inflation in meat prices appears poised to continue.

What’s the point? Long-term weather patterns, namely drought conditions, appear to be having an increased effect on food inflation. This is somewhat of a concern because it could spark a move to higher inflation generally. While we believe the likelihood that food price inflation will result in significantly higher general inflation is low, we note there have been periods in our history where sectoral inflation stoked a rise in general inflation, partly due to change in “inflation psychology”. We believe the probability that food price inflation would spark higher general inflation in the near term is low for a variety of reasons including demographics trends, structural issues with the labor force, and excess global capacity. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140523&id=17646363

 

 

Daily Bullets……For May 22, 2014

·         Leading indicator up again…..The Conference Board’s index of leading economic indicators rose again in April, up 0.4%, and was revised up to 1% gain for March. Sectors contributing to the improvement were housing and the financial sector.

What’s the point? The economy appears to be accelerating from its severe weather-induced slowdown in Q1. There is increasing evidence that the housing market is improving. The strength of the stock market also benefits the economy through the “wealth effect” and generally improved consumer and business psychology. Overall, the rise in leading indicators is consistent with our view that the U.S. economy should continue to strengthen this year, which is positive for corporate profits and, hence, stock prices. Link: http://money.msn.com/business-news/article.aspx?feed=AP&date=20140522&id=17643157

 

·         Existing home sales up…..National Association of Realtors reports this morning that existing home sales rose a solid 1.3% in April with most of the strength coming from the condo market. The supply of homes for sale also rose to 5.9 months from 5.2 months.

What’s the point? This is another in a string of reports recently that indicate the housing market is beginning to recover from the effects of the severe winter. We think there is meaningful pent up demand for housing because of severe under-building over the past five years relative to household formation. The improvement in the housing market, some of which is of course seasonal, is another factor that should add to acceleration in the U.S. economy as we progress through the year. Link: http://money.msn.com/business-news/article.aspx?feed=AP&date=20140522&id=17643110

 

 

Daily Bullets…………..For May 21, 2014

·         Low inflation for 4 more years??......Minneapolis Fed President Narayana Kocherlakota in a speech this morning suggested implementation of price level targeting by the Fed because he believes inflation could remain below 2% until 2018. It is suggested that under price level targeting, the Fed would allow inflation to run in excess of the 2% target level for several years in order to offset the effects of low inflation experienced over the past several  years.

What’s the point? We think this is part of the reason why the stock market is up today. Kocherlakota comments have several important implications: 1) provides some insight into Federal Reserve thinking that they may believe inflation will remain low for an extended period; and 2) it suggests Federal Reserve policy could remain very accommodative for much longer than many now believe. This would have positive implications for financial assets, such as stocks and bond. One other factor we believe may be at work: the Federal Reserve may be learning they do not understand inflation (and its causes) as well as they or many others believe. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&Date=20140521&ID=17640000&topic=TOPIC_ECONOMIC_INDICATORS&isub=3

·         Fed minutes reflect low inflation....In April FOMC meeting minutes released today, the Fed stated continued monetary stimulus did not risk causing higher inflation. Their reasoning: continued  high structural unemployment and low capacity utilization.

What’s the point? This is another in a continuing stream of data that 1) points to continued low inflation; 2) highly accommodative Fed policy does not appear to be changing; 3) any rate increases by the Fed are still expected to be gradual. This is positive for financial assets but does raise some concern about the underlying strength of the U.S. economy. Because global economies are much more inter-dependent, we think the weakness in Europe and slowing in China is probably having and will continue to have more impact on the U.S. economy than many now expect. The implications for investment policy are: continued balance between equity and fixed income and equity preference toward larger quality companies that have healthy free cash flow and can raise dividends. Link: http://www.bloomberg.com/news/2014-05-21/fed-sees-no-inflation-risk-in-stimulus-to-push-down-unemployment.html

 

 

 

 

 

Daily Bullets……For May 20, 2014

·         Plosser juxtaposition…….Philly Fed President Plosser stated in a speech this morning that the Federal Reserve may be late in anticipating a pickup in inflation and is at risk of “being behind the curve” in controlling inflation.
What’s the point? Plosser’s comments are quite a contrast to recent comments from both current Fed chief Janet Yellen and former Fed chief Ben Bernanke. They have both stated recently that they expect accommodative monetary policy to remain for quite a while due to high structural unemployment and excess capacity. Plosser has been known to be an inflation hawk and has been singing this tune for several years. Who is correct? At this point, we still see a lot of slack in the U.S. economy. In addition, there are other exogenous deflationary forces, particularly weak overseas growth. We think an significant acceleration in inflation is still a ways off. The signal for increased inflation risk we think will be a much tighter labor market. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&Date=20140520&ID=17635698&topic=TOPIC_ECONOMIC_INDICATORS&isub=3

·         Many still “underwater”……In a report out today by Zillow, there continue to be a large number of homeowners whose house is worth less than their mortgage, otherwise known as being “underwater”. The good news is the ratio of underwater homeowners has dropped to about 19%  from 25% a year ago.

What’s the point? The “underwater” factor is a lingering vestige of the housing bubble and has multiple ramifications: reduces available housing inventory and thereby housing turnover/sales; maintains a negative for consumer psychology (lower “wealth effect”), that may be affecting consumer spending, which has grown in this recovery at about half the rate of post-WW2 average. We believe the underwater factor will continue to gradually improve along with healing in overall housing market and consumer spending. It may also have the effect of prolonging the current economic recovery. Link: http://money.msn.com/business-news/article.aspx?feed=AP&date=20140520&id=17635723

 

 

 

Daily Bullets….For May 19, 2014

·        Continued slow emerging markets growth……A new analysis from Schroders Asset Management (U.K.) argues that U.S. recovery will remain healthy, but due to several factors, growth in emerging market economies could be weaker than most now expect. Also, due to excess global capacity, they argue for continuation of global deflationary pressures.

What’s the point? We believe the Schroders analysis argues for continuation of U.S. financial assets, primarily quality, dividend stocks, continuing to remain attractive to investors, and also implies increased valuations for these kinds of stocks. With very weak growth in Eurozone and slowing growth in China, we have been hearing the “D" (deflation) a lot more lately in financial media. The concern over deflation is not new. Key points for investment strategy: a) inflation still does not seem to be a significant threat and b) financial assets, such as dividend stocks and bonds, both of which can provide cash flow and/or a growing income stream will remain assets of choice. Link: http://finance.yahoo.com/news/4-reasons-us-recovering-leaving-084953322.html

·        Bernanke's influential comments……Former Federal Reserve chief Ben Bernanke is now on the speaker circuit providing his views at pricy, private investor meetings. In a speech given last Friday, Bernanke is purported to have stated a couple of very important things: 1) easy money policies and below normal interest rates are here to stay for  long time, and 2) Fed will move only very slowly in raising interest rates and will only do so much later than many now expect.

What’s the point? This is a rare glimpse into the “inside thinking” at the Fed and is significant. We think new Fed chief Janet Yellen is following a policy that is a continuation of the Bernanke policy. Important implications for the financial markets include: 1) the easy money, low interest rate environment we have experienced for five years will most likely continue; and 2) continues to be supportive of financial assets, particularly quality dividend-paying stocks. Link: http://finance.yahoo.com/news/big-ticket-dinners-blunt-bernanke-200233561.html

·         Contract worker nation?.......A recent Federal Reserve study shows that contract workers are growing as a percent of overall labor force, currently accounting for 2.3% of the labor force, compared with about 1% in the 1980s. And economists predict this percentage will grow in the years ahead.

What’s the point? While the percent of contract workers may seem small, the growth of this type of worker has economic implications. Some of those implications include: 1) potential for some secular downshift growth of consumer spending which, in fact, we’ve seen in this recovery, 2) secular slowing in household formation, which has implications for durable consumer goods; 3) potential for making recessions more severe. Link: http://money.msn.com/business-news/article.aspx?feed=AP&date=20140519&id=17629059

Daily Bullets……..for May 16, 2014

·        Economists lifting growth forecasts…According to Philadelphia Fed’s quarterly economist survey issued today, consensus growth estimate for Q2 is raised to 3.3%, up from 3.0% and growth in 2H-14 is also increased.  

What’s the point? Recent consensus has been that the economy should accelerate in 2014. We think that is still the case, primarily reflected in recent stronger employment growth data. However, over the past week, we have seen increased investor concerns that economic growth will be less robust than earlier expected. The reasons for this are weak Eurozone economic data (0.2% growth in Q1) and increased concerns over slower growth in China. As a result, there has been some movement into bonds and out of stocks. If growth is in fact slower than expected, we think stock market downside is probably limited due to valuation, which remains reasonable, and continued investor demand for quality dividend-paying stocks. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&date=20140516&id=17626488

·       Bullard sees inflation picking up…..In a speech today, St. Louis Fed President James Bullard stated that in his view, U.S. economy will accelerate and grow at “a robust pace” for rest of year, and that inflation should move closer to Fed policy goal of 2%.

What’s the point? It is encouraging that a Fed regional president has a more optimistic view towards the economy. The Fed does extensive and thorough economic research. Given the very slow pace of the global economic recovery, for inflation to move towards the Fed’s policy goal of 2% is probably a good thing because it reflects a strengthening economy. Despite Bullard’s comments, we believe the economy is still quite a ways from “worrisome” inflation. Europe is still dealing with significant risk of deflation and there remains a lot of capacity and labor slack in the U.S. economy. As of now, we still do not see a significant risk or probability of “high” inflation. Link: http://money.msn.com/business-news/article.aspx?feed=OBR&Date=20140516&ID=17627118&topic=TOPIC_ECONOMIC_INDICATORS&isub=3