“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” — Sir Winston Churchill
Dear Clients and Friends,
Last week my colleague Jan Weiland and I were having a conversation about the disappointing March jobs number and what that would portend for 1st quarter GDP growth. During the course of the conversation I lamented that, after 6 years of recovery, it seemed like you could still “knock the economy down with a feather.” West Coast dock strikes, a rising dollar, oil field retrenchment and a brutal East Coast winter have surely contributed to a slowing of growth but I am now hearing predictions for possibly only +0.5% GDP growth for the first quarter of 2015 (which would explain poor March job creation). Why is this the case? I don’t know for sure but I think we can still go back to the Great Recession of 2008-2009 for some answers. I continue to believe that the fear, dread and panic of that time has been forever etched into the memories of consumers and corporations. Financial behavior has changed since then. Individuals and companies have not only become much more cautious but they are quicker to alter financial behavior when they sense trouble is brewing. Today, companies will immediately cease to spend capital or hire employees if they see economic storm clouds gathering.
Today, the oil industry is a good example of what I mean. Oil prices began their collapse in August of last year and by Christmas time the industry had shut down 38% of all drilling rigs that been previously in operation. Capital spending budgets for 2015 were cut by 50% to 70%, 98,000 workers were let go and shareholder dividends were slashed or omitted completely (all in just 4 months). The airline industry is another example of how behavior has changed. The industry has been a big winner as fuel costs have declined and profits have surged. Rather than expand market share, reduce fares or omit bag fees, the industry has chosen to buy back outstanding stock and pay down debt. I am not saying this is bad, it is just a behavioral change that is not conducive to overall economic growth.
Our friend Brian Westbury, Chief Economist at First Trust, takes my hypothesis and expands on it in a different but informative way. With his permission, I have attached his viewpoints below. Also included, following Brian’s article, is a piece from Bloomberg Economics which discusses what the FED is looking for when it comes to a policy change with short-term interest rates. Could we be headed for a period of time when short-term rates rise and long-term rates stay low?
Monday Morning Outlook
Don’t “Dread” The Plow Horse
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
“Dread” is the perfect word for what many investors have felt in recent years. Some have experienced it daily since the bottom in March 2009. Some experience it whenever the stock market falls.
But dread really sweeps the markets when there is weak data, a change in fiscal or monetary policy or during market volatility. This means it has cast a pall over markets once or twice a year during the past six years.
Remember the feeling on September 2, 2011, when it was reported that payroll employment in August was a big fat zero? That was dread. Remember when real GDP in the first quarter of 2014 was negative? Dread! The thought of tapering? Dread! Or at least a tantrum.
Well, here we go again, except this time the bar for feeling dread has been lowered drastically. Payroll employment increased by 126,000 in March and some analysts reduced real GDP estimates to less than 1% for Q1. You guessed it: dread. Double dread!
There are three things going on here. First, by definition, weekly, monthly, or quarterly data is more volatile than the trend. In the 1980s or 1990s, when trend real GDP growth was 4%, a “slow” quarter was 2%. These days, the Plow Horse economy is expanding at about 2.5% annually. This means a “slow” quarter can show zero growth, or less. This is normal volatility that is mistaken for real economic trouble. In other words, we’ve reached “escape velocity,” it’s just a very low earth orbit.
Second, many analysts and investors mistakenly believe that the current recovery and bull market are “sugar highs.” They still believe easy money and government spending have lifted growth and stock prices. A sugar high, by definition, is temporary.
Third, investors still suffer from Post-Traumatic Stress Disorder brought on by the trauma of the Panic of 2008. No one alive can remember the last Panic in 1907. As a result, the world seems less stable and every piece of bad news seems like it could be another “black swan” event…even though these things are very rare.
Right now, the Fed seems to be on course for a rate hike this year. At the same time, a series of temporary or one-time events are affecting economic data – weather, the drop in oil prices and labor problems at West Coast ports.
This February was the coldest February for the most people since 1979. The drop in oil prices has undermined investment growth in drilling activity. And, a work slowdown at West Coast ports affected trade data, production schedules, and retail activity.
But none of this changes the course of the economy. It’s still a Plow Horse. Everyone, including the Fed, knows these problems are temporary. Yet, because they bring growth close to zero, and because the economy is already growing slowly, fear builds.
If the US really wants to grow faster, it must start having faith in markets and entrepreneurship, not in government. Government spending and redistribution are undermining growth. Think of it like a jockey – the heavier the jockey, the slower the horse, and the slower the horse, the more dissatisfied investors become.
None of this changes the fact that new technology is raising productivity, and returns to investment, in the private sector. The Great Divide (what some call income inequality) is caused by this dichotomy. The free market economy is booming, while the government-funded side is suffering.
The good news is that investors don’t invest in the aggregate, they invest in the companies that are experiencing higher productivity and profits. As a result, the current wave of fear and dread is just like the last wave. It’s temporary. Don’t dread the Plow Horse. It’s good for investors.
This information contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy.
Fed vs. Bond Market on Rates
By Bloomberg Brief Economics | Apr 8, 2015 | 8:00 AM EDT | 0
Financial markets and monetary policy makers continue to diverge on the expected path of interest rates. This partly expresses lack of market conviction toward the growth and inflation outlook. However, low yields may not entirely reflect economic fundamentals. Foreign capital flows into dollar-denominated assets are another important factor. As long as the Fed appears more inclined to normalize policy relative to other developed economies, the bias toward lower yields may persist.
2% Inflation Target a Goal, Not a Prerequisite
The two main measures of core inflation, the core CPI and the core PCE deflator, have both been running below the Fed’s longer-term target of 2 percent. However, the Fed has stressed a return to 2% is not a prerequisite to begin normalizing policy; rather, its members need to have confidence inflation will move toward this target over the medium term. Falling oil prices and dollar strength have depressed inflation in the past few quarters, but the latest data show prices beginning to firm.
Rising Wages Key to Meeting Fed Inflation Target
Impetus for inflation to return to the Fed’s 2% target will come from increasing wage pressures, as higher wages drive up production cost. The latter gets passed on to consumers and also raises workers’ spending power — which again supports higher prices. As unemployment moves toward the estimated “full employment” level near 5%, labor shortages will put greater pressure on wages.
Fed Moves Guidance Closer to Market Expectations
While the Fed removed the “patient” language from its guidance, patience was still evident in a downgraded economic assessment, reduced forecasts for growth and inflation extending beyond 2015 and how conditions were characterized in Chair Janet Yellen’s post-meeting press conference. In response, policy makers signaled — via the “dot plot” — that they would do less “heavy lifting” on official rates in 2015. The median point on the dot plot slipped to 0.5-0.75%.
Market Sees More Gradual Tightening Than Fed
The shift in the dot plot signaled a later start for the Fed’s rate hiking cycle, but not a slower pace — at least not yet. Current and previous dot plots show interest rates increasing at a pace averaging 125 bps per year in 2016 and 2017, regardless of when tightening begins. Markets have not taken policy makers at their word, continuing to expect a slower pace. Policy makers emphasize a “shallow” post-liftoff trajectory for the fed funds rate. That will be worth monitoring in the next dot plot release on June 17.
Inflation Expectations Begin to Rise Off Post-Crisis Lows
Bond markets expect a gradual rise in long-term inflation, which remains below pre- and post-credit crisis medians. Ten-year inflation breakeven rates have increased 30 bps since January 1 to 1.85%. Policy makers have recently expressed concerns regarding the potential for non-economic factors to distort the signal from market-based inflation expectations. The drift back in the direction of 2% on longer-terminflation breakeven rates will provide them with greater confidence that markets expect low inflation to prove transitory.
Market Still Sets Pace of Lower Rate Forecasts
Markets have reduced first quarter 2016 expectations for 10-year Treasury yields by 30 bps to 2.14% since Jan. 1, while analysts have cut corresponding forecasts by 50 bps to 2.74 percent. If market-determined inflation expectations are stabilizing on the back of forecasts for firmer growth, then nominal yields should similarly begin to reflect this change. Yet markets may be assigning more weight to the impact of foreign demand and the stronger dollar in forecasts for Treasury bond yields than analysts assume.
High Yields, Strong Dollar Drive Billions to Treasuries
U.S dollar appreciation and higher bond yields on U.S. Treasuries relative to sovereign debt from other G-7 developed countries have boosted demand for Treasury bonds by $377 billion over the past 12 months. Non-U.S. investors now own $6.2 trillion in Treasuries, half of the $12.5 trillion market. Treasury bond yields may remain below consensus forecasts should these trends in favor of higher yielding U.S. dollar assets continue.
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Tags: ECONOMY | INTEREST RATES | FEDERAL RESERVE
Best wishes to all,
–There are 482.4 million barrels of oil in inventory in the U.S. today. More than at any time in the last 14 years.
–Top performing global markets this year so far: Japan, Germany, France, Korea and China.
–If you earn $125,000 or less per year and your child is able to get into Stanford University…..tuition is free. If you earn less than $65,000…..room and board is free as well.
–WhatsApp (owned by Facebook) handled more than 7 trillion messages last year. That is about 1,000 per every person on the planet today.
–The 4 largest U.S. bottled water producers get their water from the extreme drought regions of California.
Sources: First Trust, Bloomberg, 361 Capital and CNBC
Ken Beach, President of Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.