Archive for economy

That Was Easy

by Ken Alderman, March 2017

One thing we can say for sure is that the political drama in Washington is definitely not boring. This month the long awaited “Repeal and Replace” of the Affordable Care Act (ACA) made its first appearance in the form of proposed legislation. The legislation stalled amid no Democratic support and a lack of support from the most conservative element of the Republican party. Many experts argue that the ACA is failing and something must be done and virtually everyone agrees the goal should be affordable quality health care for all.ken-alderman-website

While not an expert on the subject, it is clear premiums are up significantly in several states and insurers are leaving markets. It’s one thing to have coverage, it’s another to get quality care (just ask a veteran) and it’s still another to be able to afford the premiums, deductibles and co-pays to take advantage of the insurance coverage.

Unfortunately, our political process encourages politicians of all stripes to make promises without fully funding the costs of those promises. Since our nation lacks a balanced budget requirement, politicians can promise a new benefit, not raise taxes to pay for it and defer implementation–and the resulting economic pain–until after their next election.

Typically our politicians are very wide of the mark when it comes to fully funding a government program or understanding the effects of legislation affecting major portions of our economy. That’s how we have arrived at a national debt of nearly $20 trillion dollars with little hope that it can ever be seriously reduced. If politicians had to fully fund their promised programs and benefits, the programs and benefits would never get passed and re-election would become more problematic. But, once passed into law, how does any politician of any party take away a benefit from a voter? The answer is, they can’t and they won’t. As voters, we share the blame for allowing poor management of our country’s balance sheet.

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Monthly Market Brief- November

Each month, our Heritage Investment team publishes a market brief to provide an overview of the major factors influencing the US economy, including a summary of key sectors and the current positives & challenges.

Click Market Brief November 2016 for the November 2016 update.

Here are some key highlights:

POSITIVES

o Consumers continue to remain healthy and rounded out the 3rd quarter in September with personal income increasing by 0.3% and consumer spending increasing by 0.5%
o The October ISM Manufacturing Index reading of 51.9 signifies the U.S. economy and manufacturing sector remain in growth territory despite declining new orders and a continued contraction in backlog orders
o Average hourly earnings increased 0.4% in October to bring the year-over-year rate to a recovery peak of 2.8%
o October vehicle sales came in at a very strong annualized 18.3 million to further highlight the strength of the consumer
o October non-farm payrolls added a respectable 161,000 jobs, bringing the year-to-date average to 181,000

CHALLENGES

o While 3rd quarter annualized GDP growth came in at a solid 2.9%, 1.2 points came from exports which were largely driven by a surge in soybean exports
o Construction related spending declined 0.4% in September for a year-over decline of 0.2%

 

INVESTMENT OUTLOOK- October 2016

Making Sense of Conflicting Signals: Where is the Economy Taking Us?

by Jim McElroy, jmcelroy@argentfinancial.com
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We are living in unusual times. The U.S. economy is now in its eighth year following the “great recession”. Under normal circumstances, we would expect that a recovery lasting eight years might be a little long in the tooth: the average since 1950 has been just over five years. But this has been no ordinary recovery: it’s been the weakest since the end of WWII. Not once in the twenty-nine quarters of this post-recession expansion has GDP grown at an annualized rate in excess of 5% and only twice has it grown in excess of 4%. The average number of greater than 5% quarters for the preceding ten post-war expansions has been seven. During those ten earlier expansions, the average annual GDP growth rate was 4.85% per quarter; the current average through June has been 2.08%. Is slower better and does incremental growth last longer? Or, does the tepid nature of the current expansion serve as a warning that the economy is vulnerable to an unexpected shock? The question we’re asking — the question we’re always asking — is where are we in the economic cycle: are we closer to the beginning, middle or end of an expansion? The answer to that question is obviously critical to the timeliness of investment decisions.

Investment markets are supposed to be semi-reliable predictors of the economy. The stock market, reputed to be the best market harbinger of economic growth or decline, has been in a bull market for over eight years and is near all time highs. On the other hand, fixed income markets, sporting absurdly low yields — below 2% for ten-year U.S. Treasuries and negative for many international debts — suggest anemic prospects for the economy. So, which market are we to believe? And, to further cloud the picture, this is a presidential election year. That and the fact that the two major candidates have distinguished themselves by their unpopularity create a situation fraught with uncertainty.

The continuing strength of equity performance is noteworthy in that earnings for major U.S. corporations (i.e. the S&P 500) have been declining for the last five quarters and are expected by analysts to have declined even further for third quarter, which ended September 30th. Though much of the index’s earnings decline over the past five quarters came from the energy sector and, according to FactSet, earnings would have been mostly positive without its negative impact, this does not, on its own, justify record high prices or an almost 20 multiple on trailing earnings. Either the stock market is extremely forgiving of lackluster earnings — not its reputation — or factors other than earnings are driving stock prices. We need look no further than the fixed income markets and the level of interest rates for at least one explanation of equity strength.

There are at least two ways through which interest rates influence stock prices: through their impact on overall economic activity and through competition. High interest rates obviously discourage borrowing and encourage savings, results that reduce economic activity and limit equity earnings. In addition, high interest rates raise the bar for stock returns, causing investors to require either higher earnings and/or dividends (difficult in a period of reduced economic activity) or lower stock prices. Low interest rates, or in the current case, ludicrously low interest rates, normally produce the mirror image of the above: aggressive borrowing and depletion of savings by investors and consumers and a lowered bar for equity returns. As it happens, the current environment of near zero interest rates has had only a limited impact on economic activity: the consumer is spending more and low mortgage rates are encouraging him to invest in more home ownership, but corporations to date have been unwilling to borrow funds or employ cash savings to invest in new plant and equipment. Consequently, the effect of low interest rates on economic activity has been limited and has had very little impact on stock prices. However, the impact of low interest rates on the competition for returns on risky investments, such as stocks, has been enormous. When cash management funds are yielding less than .25% and ten year Treasuries are yielding below 1.6%, a dividend yield of 2.06% (S&P 500) or higher, with the potential for growth, looks very attractive indeed. It looks so attractive, on a risk return basis, that corporations have been employing excess cash reserves to buy their own stock rather than investing in plant and equipment. Little wonder that all time highs in the stock market are coinciding with all time lows for interest rates. All this begs the question of what happens to the stock market when central banks like the Federal Reserve begin to raise interest rates.

The Federal Reserve raised short term interest rates .25% last December and said that it expected to raise rates four times in 2016. Because of a variety of weak economic news during the first three quarters of 2016, the Fed balked and did nothing. It now is signaling that it will likely raise rates by .25% this December. We believe the Fed will raise rates in December, but will continue their message of caution and patience in bringing interest rates to levels consistent with sustainable growth. As long as the Fed succeeds in conveying this message of patience, there should be no December collapse in asset prices.

It is becoming clear, even to many central bankers, that a low to negative interest rate will not in and of itself create economic growth or inflation. Those effects, like almost everything else in economic and market activity, are driven by the collective psychology of humans behaving as humans or, as John Maynard Keynes called it, “animal spirits”. Among investors it’s called fear and greed. Without the presence of optimism among economic participants, reducing interest rates to extremely low levels in order to produce growth is only so much pushing on a string. And, as many have seen over the last few years, it can also be counterproductive: desperately low rates can produce a degree of pessimism that may discourage investment and the assumption of risk. On the other hand, lifting interest rates from very low levels may not discourage investing and risk taking when in the context of growing consumer and investor optimism. And, at least domestically, consumers and investors appear to be demonstrating an incipient degree of optimism: U.S. consumer confidence has been climbing since May — the latest reading places it at its highest level in nine years (since just before the last recession); and the stock market is hovering within 2% of its all time high, which was set during the current/third quarter.

We’ve already mentioned that the absence of competition from bonds has provided a support to the equity markets. With rates set to increase, this support could slowly disappear, a future well appreciated by stock investors. Since the stock market has the reputation of discounting practically everything, we may assume that the market at current levels is not overly concerned with a .25% increase in overnight rates. However, in order for the stock market to grow from current levels, investors will have to believe that earnings growth will make a long awaited appearance sometime in 2017. In order for that to happen, there needs to be a lift in GDP well above the “muddling through” pace to which we’ve grown accustomed.

It seems to us unlikely that a 2% GDP growth rate will last indefinitely: it will either accelerate or the economy will slip back into a recession. In addition to the increases in consumer confidence mentioned above, there are signs that the U.S. economy is improving: the unemployment rate has declined to 4.8% and payroll employment is holding steady; perhaps more importantly, the labor participation rate, after having declined for most of the last nine years, appears to have bottomed (at 62.8%) and begun to rise; the housing market is steadily improving and new home prices are closing in on levels not seen since before the last recession; and the Federal Reserve, after having modestly lifted short rates from zero last December, now finally sees enough strength in the economy to consider another increase. As long as the Fed raises rates gradually — and they say that they will — then we see no reason why the domestic economy won’t benefit from higher rates. Perversely, there may be nothing like higher capital costs to quicken the animal spirits of corporations and investors. If this is correct, then this long recovery may last even longer and we might actually see significant growth and returns on invested capital.

For more information about the commentary found in this newsletter, please contact a member of the investment committee.