Investing is a confidence game. Without a certain expectation of return, no one will defer current consumption and invest for future consumption. Currently, we are being overwhelmed by a lack of confidence in that return. People have been fed a fairly steady diet of bad news about nearly everything and never given the whole story in such a way as to increase that expectation of return. It was Will Rogers who quipped “I’ve stopped worrying about the return on my money. Now I just worry about the return of my money.” We all have a piece of Will Rogers in us these days. But, the big question is whether that attitude is warranted and will it continue?
The news flow is never all good or all bad. It is inevitable that some good news will leak out even during times when most folks look for bad news to validate their point of view. We optimists always have acknowledged the bad news because it is there and it seldom escapes notice. Pessimists don’t seem to play by those same rules. Right now there are millions of people getting jobs in America while at the same time millions of other people are losing jobs. On a monthly basis, we get the net of those job getters over the job losers, but on a weekly basis we get an extra dose of the job losers data. That isn’t fair. (By the way, should it surprise anyone that as the Census Bureau lays off a couple hundred thousand temporary workers, there has been a blip in initial jobless claims?)
We get a monthly dose of data on housing that shows that essentially the housing industry is stuck at a very low level of activity. If we are honest about it, the housing sector hasn’t gotten materially worse in over half a year. Most of the data on home sales, home prices and home construction has been going sideways since late last year. It isn’t getting better, but it isn’t getting worse either.
We get data on a monthly basis for consumer spending and incomes. This data has been in a mildly upward trend lately. We all wish it were gaining at a faster clip, but it is just inching ahead. Our savings have been getting a lot stronger and our debts have been slowly subsiding, both good trends. What moneys that are used to bolster savings and pay down debt could have otherwise been used to buy a new shirt or handbag. But we are opting to save these days. Incomes have been gaining, both from rising wages and an increasing labor force. But, the progress is painfully slow.
The point is that things are getting better, just not at the pace we’d like to see. We had expected better than this and we’re being disappointed. On the plus side, our expectations, having been dashed, are now much lower. Any economic number that does not validate a slide into the abyss should be treated as manna falling from the sky.
So, we expect to see consumer confidence slowly return from the recent dip. Not so much because the outlook will suddenly get rosier, but because our expectations are now so low that some improvement is due. We can expect to have several pieces of good news between now and the mid-term elections in November. First, we suspect that most of the people running for Congress (the opposite of progress) will be trying to avoid raising our taxes right after the election. If we were running, trying to save our cushy job, we’d be all in favor of doing the economy and most of my constituents a big favor by not raising their taxes. Even if not everyone can avoid having their taxes raised, limiting the damage by extending the Bush tax cuts for a couple of years seems like a slam dunk.
Second, once all the complications from temporary Census workers have past, we suspect that we’ll continue to get mildly positive employment reports over the next several months. The reports probably won’t show hundreds of thousands of new jobs, but tens of thousands are likely. Both the ISM Manufacturing and Non-manufacturing surveys have indicated an increase in hiring by corporations in recent months. That should mean that there is a small push in private sector employment. The recently enacted ‘second stimulus’ should slow government job cuts. The combination should give us some better than expected jobs reports.
Then, we have the annual rite of people shifting their focus from the current year to next year as this one runs down. As we do that, we tend to take a somewhat longer view and that may help in seeing the improvement. When it comes one month at a time, there isn’t enough improvement all at once to change our attitude. But, when we look forward and see a year’s worth, even at a modest rate, it adds up to a lot more good news. 2011 may be the solution to 2010s problems.
Issue of the Week
Last week, the issue we took up was deflation and just how bad it could be. This week, let’s look at inflation and see just why it has been so low and why it may remain low. If you were one of the statisticians at the Bureau of Labor Statistics, you’d look at the world as a series of subsets of data on what we buy and what we pay for it. The BLS gets reports from many sources and they also send out their own investigators to gather data on retail prices. They follow a broad ‘market basket’ of goods the typical American purchases on a regular basis, though the market basket includes funeral services along with toothpaste. The big parts of that market basket are food, energy, other commodities ex-food/energy and services. There will be months when we hear that cigarette prices made the CPI jump or like this month when energy prices were the culprit.
The statisticians keep sub-indexes for each of the major and minor segments of the market basket and then sum those sub-indices to get the overall number. The weights they assign the sub-indices are important to the final number. One of the bigger slices of the index is shelter costs, what it costs to live somewhere. This section makes up roughly 40% of the CPI weight. When you deduct the energy services, essentially gas and electricity delivered to the home, you get a large third that is rent.
Most Americans (almost two-thirds still) own their homes, but the statistic that goes into the CPI is what they term ‘rental equivalency’. This is a number that the BLS folks derive that roundly (very roundly) equates to the rent you’d have to pay if you rented your home from yourself. We think you’d give yourself a pretty good deal, but the BLS number-crunchers suppose that the deal would be a fair-market rent, whatever that means.
The trouble started back in the 80s, when house prices made up a big chunk of the CPI, the rapid rise in house prices made a huge impact on the number. They made the change to rental equivalency to keep house prices from taking over the CPI. This meant that the huge rise in property prices during the housing boom didn’t show up in CPI, except as a small impact on rental equivalency. Now, rental equivalency could be a very solid contributor to inflation over the next several years. With a reluctance to buy homes while the prices continue to be soft and a shortage of credit even if you did want to buy, there are many more people renting than just a couple of years ago. There is an impending shortage of rental housing, rents are primed to go up.
There has been a long history of the goods portion of the CPI rising at a fairly modest and unpredictable pace while services rise at a rapid and persistent pace. Areas where goods have to compete globally, there has been restraint on prices, while services don’t usually have to compete globally, so their prices are on the escalator higher and higher. The more services in the basket, the more certain inflation is going to make a comeback.
The US Trade Balance was more negative than expected. While trade has been one of the better stories in this recovery, it has turned-out to be largely a reflection of US consumers’ declining appetite for goods. As consumption has recovered, a disproportionate share of that demand has gone to imported goods. We can’t even dump this on our favorite whipping-boy, oil. Imports grew 3% while exports declined (that’s right, declined) by 1.3%. One significant piece of the decline in exports came in the agricultural sector, which has been a fairly dependable growth sector of late. The absolute deficit was $49.9 billion, which is the worst since late 2008 but a long way from a record. The US halved the trade deficit during the recession as our appetite for foreign sourced goods dropped, especially oil.
Retail sales rose 0.4% in July with the ex-autos number hitting 0.2%. Both numbers were generally in line with expectations and show a decent, ongoing level of retail activity. Much of the gain was due to gasoline sales, which showed a 2.3% gain from June due mostly to higher prices at the pump. The gain for retail sales from July a year ago is 5.5%, nothing to brag about, but nothing to be ashamed of. Below the surface, the details weren’t all that encouraging with many major categories of retail declining like department stores, building materials, appliances and furniture. Sales rose at restaurants and bars and for on-line retailers.
The Consumer Price Index rose 0.3% in July from June. Energy prices rose by 2.6% while most everything else gained very little. The core rate, which excludes food and energy prices, rose 0.1%. Both numbers were in line with expectations. Over the past year, CPI has gained 1.2% while the core version has gained 0.9%. As a postscript, it is odd to get the CPI prior to the release of the PPI, but that is what we’re getting this month.
Consumer sentiment was better in August. The change from 67.8 in July to 69.6 in August leaves the number at a low level, but any improvement is still improvement.
As one member of our punditry team so succinctly put it – ‘risk on, risk off’. We had a serious bout of ‘risk off’ this past week. Gold was up, the dollar was up, Treasuries were up, government bonds in most of the developed world were stronger, stocks were down, oil was down, and the Euro was down. Risks came off all over the place. The S&P was down the best part of 4%, but the Russell 2000 was down slightly more than 6%. The only stock market among those we routinely monitor that was higher last week was India, though the Swiss were barely down on the week. Safe havens were where people wanted to put their money, Treasury bonds were about 2% higher for the week, the dollar gained 3% versus a basket of major currencies.
The risk trade comes off and the risk trade goes on. It seems, though this may be just another of our behavioral finance perceptions, that the trade comes off a lot faster than it goes on. The bulk of our losses last week came in two bouts of selling early on Tuesday and Wednesday mornings. Most of the bad news last week was actually overseas and what we saw here was generally the US market reaction to bad news triggering selling somewhere else. It is funny how much the world markets have become self-reinforcing bad news machines. But, bad news in say Japan is felt around the world in a single trading day. But, in the world of ‘investors’ hedging their Japanese positions with German stocks and their German positions with US small caps, all it takes is one domino to drop and all the others come crashing down.
Assuming you read the economic news above, the news here wasn’t all that good nor all that bad. The trade deficit was a surprise, but the CPI number was a relief from the deflation concerns. There wasn’t enough home-grown bad news to justify the market reaction, but when you have friends like these . . .
Foreign markets were hurt by news from Japan that their economic growth has already ground to a halt. Even their export sector wasn’t showing much growth, while domestic demand is still stuck in low gear. This more than offset the relatively good news out of Europe that German production was up. By and large, the emerging markets were quiet and went along with the developed markets down the toilet.
Bonds were pretty happy with the turmoil. Most government bond markets were higher. The flight to safety helps US Treasuries, British Gilts, German Bunds, Japan Government Bonds and other highly regarded, liquid markets. There wasn’t quite as much follow-through in the other high grade markets (mortgages, corporates, and municipals) as we’ve gotten used to. The focus on low risk has gotten more focused as we’ve gone further down that path.
Real estate securities were generally down about as far as the stock market and followed the financial sector down along with the market. Much to our chagrin, the international segment of real estate was down more, largely due to the large share of that market in Japan.
Commodities were widely lower on the week. Energy prices lead the way, but industrial metals, agricultural commodities and softs were largely down. Precious metals were mixed with gold higher but silver declined.
Have a great week.
Karl Schroeder, RFC, CSA
Investment Advisor Representative
Schroeder Financial Services, Inc.