Volatility is back it seems. Four of the five days last week saw prices of the Dow Jones Industrials gain or lose 100 points at some time during the day. Why? Some would argue that it is due to the news from Libya and the oil markets. As we have mentioned a few times already, oil really shouldn’t be an issue because there is plenty of oil. Libya is a lot bloodier affair than either Tunisia or Egypt, but Libya is hardly a big element in the global scheme of things. We think much of the volatility comes from a couple of more mundane sources, greed and fear.
Last week, in the Weekly Stuff section, we argued (somewhat off the cuff) that the trade was into oil and out of everything else. Oil is the driver of most of this volatility. When oil markets go up, nearly everything else goes down. When oil markets go down, nearly everything else goes up. This is driven by fear and greed. If you think oil is going to go to $150 a barrel, buying it at $100 a barrel is a bargain. When you can buy a lot of barrels for pennies on the dollar that is even better. So once again we have that age old problem of the futures pits jerking the rest of the market around.
For most long-term investors, this is just a side-show. Unless something very unusual happens, this whole thing will blow-over in a matter of weeks to months. When it does blow-over, we will go back to looking at things that really count, like valuation, fundamentals, economic growth and so forth. Unless you think you can call the beginning to these bouts of volatility and also call the ends accurately enough to profit from playing them, please don’t try. Few can do that, though many try.
We spoke about time last week as well. Time is your friend if you’re an investor. The more time you have the better. Over time, the millions of people working as hard as they can, as smart as they can, to make the big companies we invest in more and more profitable, succeed. Sure, not every company prospers like we’d like them to, but most do. Some fail, most do not. Investors who think and act long-term can usually win at this game. Buy things that make sense to you for the long-term and stick with them. Sell when you think the future has changed against you. Be adaptable, be flexible, but don’t be short sighted. It’s really as easy as that.
In the investing world, we often hear about ‘buggy whip’ companies, those that have outlived their useful lives. They have been obsoleted by new technology or new concepts. There are lots of the next generation of ‘buggy whip’ companies all around us today. We just don’t know which are ‘buggy whip’ companies and which aren’t. Some of the most dependable companies have the most mundane products. Have we come up with a better band-aid? Have we come up with a better idea than toothpaste? Some day we will and on that day we’ll have to rethink band-aid and tooth paste companies.
The important thing is what happens in Libya will have only a tangential impact on what happens to most of us in the future. Do you know of anyone who is postponing buying a new dishwasher until the future of Libya is decided? Didn’t think so.
Issue of the Week
We have intentionally avoided the whole public sector union fracas until now. And, we will probably have wished we continued to ignore it after today. But, it does touch on a couple of important economic elements, so cannot be totally ignored. So, now that some of the worst of the heat from the Madison, Wisconsin capitol sit-in has cooled, let’s take a look at some of the basis for this situation.
Do we need schools? In a modern economy with so much of the labor force involved in ‘knowledge industries’ the obvious answer is yes. Do we need teachers? If the answer above is yes, it doesn’t make a lot of sense to have schools without teachers, so yes. Now, the critical question, do we need public schools? That really isn’t all that clear. Before we answer that question lets define the question a little bit more. There are really three school systems in America, elementary schools, secondary schools and colleges. Each is somewhat unique.
Elementary schools teach our young children the basics, how to read and write, add, subtract, multiply and divide, a little history and so on. But, elementary education can be and was done in the home for centuries. By the time they are adults, most parents could easily teach their kids to read and write, assuming the parents had been taught as youngsters. The kids would get the one-on-one attention they deserve, and the parents would develop a special bond with their kids. Of course, the outcome of this system would be a little spotty, but secondary schools could probably overcome that.
Secondary schools (depending on your definition either middle school, high school or more likely both) teach children somewhat advanced versions of the above list and also prepare these children for college or for a trade. Historically, not all children have gone to secondary school as it often meant paying money for the privilege and sending the kid off to the next town. It is widely accepted that real teachers are needed to teach these advanced concepts and methods (while elementary school teachers have a sizeable baby-sitting element in their workday).
Colleges have been around since at least the middle ages (and arguably since ancient Greece), usually seen as centers of learning where the best and brightest pass on their knowledge to the next generations’ best and brightest. These are the places where the leaders of every age derived their understanding of the world and the knowledge of history, literature, arts and science. But, mostly they have been about teaching our next generation of teachers, lawyers, doctors and priests. The range of degrees has certainly broadened since the old days, but still college isn’t about learning a skill, it’s about amassing knowledge that can be applied to new and different problems.
We have public schools (i.e. government-run schools) largely because by the middle of the 1700s many European countries had adopted a system of public education. That trend hit America, hard. Colonial America had very little in the way of established private schools, so no competition for public schools. Much of our current school system dates from those days. Our school year is predicated on children needing to be free to work at home, usually on the farm, during the harvest season. That is something which is largely unnecessary, but if you really want to tick-off your teacher friends, suggest they work twelve months a year, for the same money.
Public education is fairly new in the greater scheme of things. Education for any but the richest couple of percent of the populace is something new as well. Read the biographies of many of the enlightenment leaders and see that many made a living as private tutors to wealthy families or professors at this or that college.
The American people essentially made a bargain, we’ll all send our kids to school, but only if we all pay for it. Public education means public payment for education. Except for the crowned heads of Europe, the public seldom paid for anyone’s education until the 18th century and then it was usually a very local thing. Even today, a public education isn’t widely available in much of the developing world.
A public education at the elementary level has to compete against ‘day schools’ (especially in many Eastern US cities) where the affluent send their children. Parochial schools still exist in much of the US for families who want their kids taught by nuns and religiously minded folk. There are a lot of other private schools, mostly funded by the folks who send their kids there. So there is a modicum of competition in elementary education.
It gets a little easier to find alternatives to public schools at the secondary level but it is still costly. You have the same religious element in many of the choices, but there are private, secular schools available as well.
It is at the college level that public schools compete most directly with private schools. Again, many of the private colleges and universities have religious backgrounds, as many of the earliest universities in the US were founded by religious orders to train their next generation of clergy. In the US, we have what are often called ‘land-grant’ colleges. In the 1860s and again in the 1890s, Congress passed legislation to provide support for public colleges, usually for the purpose of teacher training or development of the agricultural sciences. A&M is a widely used designation for land-grant schools. Along with other publicly supported colleges and universities these schools are some of the largest universities in the nation.
So, we have a system in which public schools compete head-to-head at all levels but with that competition most heated at the college level. When nations across the globe send their best and brightest students to the US to attend college, but American citizens avoid local, public schools to send their children to private day schools, it appears that what we need is more competition at earlier stages of schooling.
There is no reason why public schools at the elementary and secondary levels should respond differently to economics than colleges and universities. Excellence is best achieved when different approaches to solving a problem are allowed to compete. The best succeed, the worst adapt. As with so many areas where government intervenes, the worst are maintained long after better alternatives are shown to work. Getting government out of education may not be possible, but getting competition into education looks like the way we ought to go.
Personal Income rose 1% in January, due to the temporary suspension of 2% of the payroll tax (that’s FICA on most people’s paychecks). The math doesn’t quite work out the way you’d expect. Why wouldn’t income rise roughly 2%? Well, not everybody pays FICA and not everybody got the cut. And, January is a big month for bonuses and FICA often doesn’t get applied to bonuses. It looked like most folks saved most of their increase since…Consumer spending rose only 0.2% in January. The small increase like so many other things can be partly blamed on weather as much of the Eastern Seaboard was again hit by winter. Due to the mismatch between income and spending, the Savings Rate went up to 5.8% of incomes in January.
The ISM Manufacturing Index rose in February to 61.4% from 60.8% in January. At this stage of the economic cycle, this is a very good report from manufacturing. This number shows that the goods producing side of the US economy is still growing rapidly. There are still risks in the outlook however, as prices paid continue to move higher. Also, hiring is likely to continue as the hiring index remained above 60%.
ISM services also rose, just not quite as much. The index was reported as 59.7% for February compared to 59.4% in January. Gains were widespread across the subordinate indices. Critically, the employment index increased from 54.5% to 55.6%, indicating that services saw expanding employment.
Motor vehicle sales were pretty darned fantastic in February (about the level they were in the early 80s). Of course, the comparison to a year ago was pretty darned easy, but the gain is helpful. Since most of the cars and trucks sold in February were built in December, that might also mean that GDP for the fourth quarter might get revised up a bit. But, it also means that consumer spending for the first quarter will be better than previously expected. The gain was especially good for General Motors and Toyota, though just about everybody had good sales. The comparisons for GM and Toyota were especially easy. Notably, incentives given to customers have dwindled in recent months as sales volumes have improved. It seems many customers don’t need the same bribe to go into the showroom as they used to.
Productivity rose by 2.6% in the fourth quarter. This is confirmation of the earlier estimate last month. Gains in productivity are essential to maintain economic growth above the growth in the labor force.
The monthly Employment report was released on Friday and it showed continued gains in employment across a wide spectrum of industries. A total of 192,000 new jobs were created in February, better than forecasts of a week ago, but below guesses just before the announcement. The one area of notable weakness was in government employment, which fell by 30,000 in February. Both December’s and January’s jobs numbers were revised meaningfully higher, December by some 31,000 and January by 27,000. What we find interesting is that by the time revisions are counted, the actual number of jobs created in the economy is pretty darned close to the forecasts from leading economists. The initial reports have been far lower in recent months, but with revisions, we are actually pretty close to the jobs number that jibes with the overall growth in the economy. December was originally reported as 103,000 jobs, now we’re up to 152,000. Why anyone focuses so much attention on such a suspect number amazes us, but it is the most watched economic number each and every month.
The Unemployment rate was found to be lower again, now 8.9% of the labor force is unemployed. The unemployment rate has fallen from 9.8% in October to 8.9% in January that is the fastest drop since 1958. Unfortunately, the drop is mostly caused by people leaving the workforce rather than jobs growing fast enough to absorb new entrants to the workforce. (The household survey, which gives us the unemployment rate, is taken of 60,000 US households. Each month, the Labor Department drops 10,000 current households from their survey and adds a new 10,000 homes, households are in the survey for six months. This survey gives us the labor force data that is crucial to the understanding of the labor market. The jobs number comes from a separate establishment survey of some 400,000 employers across the country who report changes in their workforce to the Labor Department monthly. The establishment survey largely excludes small businesses and proprietor ships and so workers in those areas must be discovered from IRS data on new W-4 forms received.)
Average hourly earnings rose 1% for the month and average workweek was unchanged at 34.2 hours.
First, remember that Monday was in last week and this week started on Tuesday as far as we’re concerned. The week we had was down, the week from a calendar perspective was up.
US stocks were up and down and up again and down again all last week. The best of it was on Thursday, while the worst was on Tuesday. Friday was the decider for the week. If you missed the Monday up, then your week was down.
We look at this environment a little differently. We have had a little correction here from the extended rally that started last November and that rally was merely an extension of the rally from July to October. We’ve had two little corrections along the way from Dow 10,000 to Dow 12,400. We needed a break and the Egypt/Libya news was perfect for that. (Kind of like when the computers go down in the office and everyone just kind of starts talking like it was a picnic or something.) We haven’t broken 12,000 on a closing basis yet, and even if we did, there is no serious technical meaning to that level. From July to October, we gained 1,500 Dow points and gave back 500 in the correction. From November to February, we gained 1,400 Dow points and have given up 400 in this correction. We have undone the overboughtedness of the market and now can set our sights on higher ground on the next rally. This thing is far from over.
We really like the fact that what little bullishness had built up among investors since November evaporated like spring dew as soon as there was trouble. The AAII survey had touched above 50% bulls before Christmas, but has since dissolved back below 40%, near normal bullishness.
Overseas markets were very interesting this past week. The Egypt/Libya correction has really hit the emerging markets, but last week saw EM start to get back on track. This is especially important for the non-materials oriented emerging markets, China, India, Eastern Europe, and East Asia. The resource-rich emerging markets, Brazil, Russia, and others, will do just fine in the inflationary world economy that seems in our collective future. Higher materials prices will buoy their prospects. But, resource availability will be the question for the manufacturing plants in China, and whether they can pass higher prices on to end-consumers. We have seen that resource economies are perfectly willing to supply a hungry market so long as there is product available. There is no pro-inflation league of nations trying to push-around the manufacturing sector like OPEC did back in the 70s.
The last wrinkle in this fabric was the sudden reawakening of the Euro. Just a hint by the European Central Bank that they might raise interest rates at their next meeting was enough to send the Euro higher. Should the ECB actually follow-through and raise rates in April, the Euro could soar, dragging many of the Euro markets with it.
It was not a great week for bond markets in much of the world. US Treasuries gave back much of the rally from the prior week. This had a muted impact on many other segments of the US bond market, as mortgage-backed bonds, high grade corporates and munis all ended the week higher than the week before. High yield bonds did especially well.
Foreign bond markets were also generally off on the week. The onset of violence in Libya scared many investors into bonds and government bonds at that the week before, but as we’ve gotten more comfortable with the fighting in Libya, we’ve come out of our safe havens to trade more normally. Emerging market bond markets also tended to get knocked down some more even after the knock they took the week before. We suspect that this will be short-lived as there is more going on in emerging bond markets than oil, Libya and inflation.
Real estate securities got whacked for the week in somewhat belated realization that all is not well in that corner of the world. US REITs were hit especially hard. Well, financial companies of all stripes tended to get hurt last week, but REITs aren’t really financial firms. They just get lumped in with them from time to time for convenience. From what we can see, international REITs weren’t hurt all that badly and many markets actually rose.
Commodities were a big story again last week. The oil story continues to dominate the headlines, but the grains story vies for space further down the page. Grains have broadly exploded. Wheat is up about 80% since last year this time. Corn is up over 50%. Rice has been in short supply since tropical cyclones hit several rice growing regions. Asia wheat crops were hurt by drought in one corner or the continent and flooding elsewhere. Russian crop failures last year meant we had low reserves to start this crop year. This would be a great time to stop paying American farmers to not plant acreage in support of prices. Prices do not need support this year; they may next year, but not this one. Let them plant fencepost to fencepost and feed the world. Grain is one of America’s great exports and we curtail it unnecessarily. Oh well, we aren’t likely to see anything in this vein, even in a year when fiscal restraint is not only necessary but popular. Another good reason to keep commodities in our portfolios all the time.
Have a great week.
Karl Schroeder, RFC, CSA
Investment Advisor Representative
Schroeder Financial Services, Inc.