Summary
The U.S. economy has likely entered a period of "Sagflation," defined as sagging economic activity combined with greater price instability. The dwindling ability of the government to stimulate the economy, both monetarily and fiscally, likely causes a period of economic rationalization. The increasing efforts of the Federal Reserve to "print money" to fend-off deflation likely produces wider price swings as money sloshes around the economy unevenly. The weaker economic growth coupled with greater price uncertainty is a potentially lethal combination for stock valuations, or at least increases volatility. In this environment I expect indexes to swing wildly and generally decline over long periods of time. Investors following a passive U.S. index-related strategy may not see growth in their portfolios for extended periods, unless they time their entry and exit perfectly. U.S. stock picking will be harder and greater weighting should be placed on U.S. exporters and international investments.
The Situation
On June 26 I posted: "If the economy slips backward I would expect to see more focus on non-traditional monetary policies to stimulate inflation." This month the Federal Reserve, after an extended internal debate, decided to reinvest maturing mortgage investments back into Treasuries. In
the Wall Street Journal yesterday is an editorial by Alan Blinder, the former vice chairman of the Federal Reserve Board, in which he states, "the bad news is that the Fed has already spent its most powerful ammunition." He then goes on to discuss the four traditional options left for the Fed, which are purchasing more assets, effectively trying to talk up investment spending, cutting the interest rates on reserves to zero or even negative, and easing up restrictions on healthy banks to enable lending. I would expect to see the Fed try a mix of all these options by the end of the year if the economy continues to slow. If the slowdown deepens then I expect to Fed to move to more non-traditional actions in 2011 that may include buying other asset classes and actively devaluing the dollar.
So will these monetary actions pull us out of the ditch? Or, should an investor remain face-down while an economic tornado rips across the country? If investors pick-up their heads, where are the best opportunities. To answer these questions let's re-visit the underlying trends in the economy.
"What man is, only history tells." - George Mosse
A String of Powerful One-time Stimulants since 1981
From May 1981 to September 1992 the Federal Funds rate dropped an astonishing 17%, from 20% (yes, 20!) to 3%, where it stayed until 1994. This amounts to a massive stimulus that likely set an elevated "normal" expected rate of growth in the economy, in my view. In my opinion, it enabled companies to continually invest in more marginal projects and still create an economic profit. In April 1991 the Federal Funds rate dropped below 6% and has since only briefly re-touched that level in 1995 and 2000. As I argued in a June 26 post, by dropping the federal funds rates and talking down the yield curve, thus lowering the cost of capital for businesses, the government can create economic profit for companies. This action helps healthy companies recover that were temporarily impacted by an economic slowdown. As a side effect, the Fed action also enables weak companies to remain in business. For proof of this point, read "Weak Firms Pile on Debt and Trouble" in today's Wall Street Journal. If monetary policy is over-used to stimulate growth then I believe it creates longer-term structural problems.
In the 1990's the inflation rate appeared to become more loosely tied to the growth in money, a breakdown in monetarism economic theory. Alan Greenspan explained the phenomenon as a result of a virtuous cycle of productivity and investment. The 1990's was the decade of "creative destruction" of management structures as companies adopted more networked technology and eventually the internet, which enabled lowered cost structures (and thus helping to offset price inflation pressure). The improvements in productivity were extended beyond 2000 by technology advancements and outsourcing to lower labor cost regions, like India for services and China for manufacturing. In 1997 the Fed began expanding the money supply in anticipation of Y2K and continued growing it on average by over 6% each year through to today, with few signs of inflation.
By highlighting these historical trends I hope to show that: (1) economic profit growth was artificially accelerated for almost 30 years, (2) weaker companies have remained in business, thus increasing price competition amongst all companies, and (3) business has enjoyed an unusual period of improving efficiency that has helped offset inflation pressures. These trends were finite in nature, and thus the question becomes: What next?
The Age of 'Sagflaton' in the U.S.?
Sagflation has been used to describe several different economic situations. For my purposes, I define sagflation as a general economic decline combined with price instability, both within industries and the economy.
The current slowdown in economic activity is a reversal of 20-plus years of government-enabled over-investment, in my view, which had produced above-sustainable growth. As explained in the previous section, the period of super-charged growth was driven by aggressive fiscal and monetary policies, as well as an unusually powerful period of business-driving technology advancement. The 5-10 year economic outlook now includes the unsavory mix of: (1) interest rates moving away from low single-digits, (2) higher capital gains and income taxes, (3) rising labor costs as U.S. immigration is tightened and wages increase in China and India, (4) potentially higher commodity prices as more countries compete for resources, (5) greater U.S. government austerity (or ballooning deficits), and (6) increased regulatory oversight.
Either cash flow needs to improve or invested capital needs to shrink in order to allow overall ROIC to recover above an increasing cost of capital, and therefore create economic profit. The biggest concern is a virtuous cycle in which capital rationalizations cause declining business activity, which results in lower cash flow generated from the existing capital base, which in turn causes additional capital rationalization.
Real world check: The NFIB Research Foundation's Small Business Economic Trends for August 2010 highlights that a majority of small businesses have, for almost 2 years, dropped prices in the past 3 months. This is extraordinary for both the length and percentage of companies actually cutting prices for their goods or services. For the 35 years prior to 2009 the survey almost always showed a majority of companies increasing prices and only a few times showed even parity between the number of small businesses raising and lowering prices. My interpretation of these figures is that there are too many resources (invested capital) chasing too few customers, or put differently, there is over-capacity since these businesses do not have pricing power. These data points suggest a period of deflation until the capital base is rationalized to a level in-balance with lower demand trends, higher tax rates, and rising cost of capital.
On November 21, 2002 then Federal Reserve Governor Ben Bernanke stated in a speech on deflation, "By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation." 1
From Mr. Bernanke's statement I believe he will aggressively utilize mechanisms to increase the money supply to offset the natural tendency of the over-invested economy to deflate, or sag. The problem with this strategy, especially in the short-term, is what Keynesian economist refer to as "pushing on a string." In other words, it is hard to increase inflation with monetary policy. Instead you may just put a lot of loose pricing dynamics into the economy without a general increase in prices. I argue that we have seen this manifested in dotcoms, housing, and now treasuries. I would even argue on-going double digit price increases in healthcare was another manifestation that the government had to address directly.
If demand trends sync-up with the invested capital base of the economy (for example - U.S. exports increase as the U.S. dollar declines), enabling greater pricing power for companies, we could see spikes in prices if too much slack is in place. The Fed would likely argue that it could tighten policies to restrain inflation, but this is my point: An overly active and aggressive monetary policy that produces large swings in the money supply likely produces widening swings in prices, in specific industries, asset classes, and in the economy as a whole. This will likely, and has already, create significant fundamental challenges for businesses.
Thus I see an outlook of flat to declining economic growth with increasingly volatile prices, or as I term it - Sagflation. Buckle up!
Note: The Small Business Economic Trends is a copyright of the NFIB Research Foundation and can be found here: http://www.nfib.com/research-foundation.
Friday, August 27, 2010
Monday, August 23, 2010
Setting a Course Through Anticipated Turbulent Times
In this entry I layout my current expectations for the remainder of 2010, and how I expect to initiate positions to make money in 2011. My views are by no means set in stone and I expect to fine tune my views as future events unfold.
August 23 - September 10: Calmer period as investors consider recent economic trends. During the next two weeks I plan to develop investment ideas for the fall and take a position in the VIX, ideally below $20 but more likely around $22-23.
September 13 - October: Increasing volatility as a number of economic signals are published and companies begin reporting earnings, which likely offer at best mixed signals and at worst the start of a more significant slowdown, in my opinion. The source of the slowdown in the U.S. is a combination of tighter mortgage standards, higher credit card rates, and weak employment. Given the overall high level of debt in the country, these factors are powerful brakes, in my view. I also expect to see increased anxiety between countries, either due to renewed debt worries within European countries or talk of military initiatives like Israel striking Iran, as discussed in the recent edition of The Atlantic.
I expect to see declining equity prices and rising treasury prices, with potentially a "black swan" event before the end of the year. International equity markets likely react negatively to increased worries in the U.S., offering opportunities to establish positions. The U.S. dollar likely strengthens during this uncertain time as investors flock to perceived safe havens, providing greater purchasing power for domestic investors outside the U.S..
In 2011 I expect much more drastic efforts by the U.S. government to jump start the economy. Potential actions include: (1) Aggressive efforts by the Federal Reserve to keep interest rates low and expand the money supply; (2) Increased political activity centered around both stimulus spending and tax cuts, with deficit hawks pushed to the side; and (3) Growing discussion by investors and media about a fiscal crisis at the state and local level with announcements of service shutdowns (examples from recent news include: furloughing employees in CA, efforts to reduce pension and healthcare costs in Illinois, and closure of transit services in GA). These issues likely encourage foreign investors to reduce their exposure to the U.S., such as China's recent sale of $24 billion of U.S. Treasuries.
While the Federal Reserve likely attempts to keep interest rates low in 2011, at some point market dynamic could overwhelm its efforts if foreign investors decide the U.S. is going down an unsustainable path. This is where it gets scary with the likely popping of the Treasuries bubble, leading to higher interest rates and potentially accelerating inflation. For this reason, I would rather position myself on the inflation side rather than the deflation side going into next year.
Starting in September through the end of the year I expect to initiate positions opportunistically. I expect to over-weight international equity exposure, in general, with greater emphasis in Asia and South America. I plan to invest in variable rate debt to cushion myself from rising interest rates. I also plan to take a position in an inverse Treasuries ETF to capitalize both on the inflating of the Treasury bubble and its potential decline. I will make a few strategic investments in U.S. equities, early on focused on high dividend yield and later on stocks that have been overly sold with solid growth potential. Finally, I will take a couple positions in metals that likely benefit from demand trends outside the U.S.
Note: Do I expect events to unfold according to this script? Of course not. I do expect events close to what I have described, but I've learned that timing is always shorter or longer than anticipated. Thus, I use this post as a way to organize my thoughts and a baseline from which to make adjustments going forward.
August 23 - September 10: Calmer period as investors consider recent economic trends. During the next two weeks I plan to develop investment ideas for the fall and take a position in the VIX, ideally below $20 but more likely around $22-23.
September 13 - October: Increasing volatility as a number of economic signals are published and companies begin reporting earnings, which likely offer at best mixed signals and at worst the start of a more significant slowdown, in my opinion. The source of the slowdown in the U.S. is a combination of tighter mortgage standards, higher credit card rates, and weak employment. Given the overall high level of debt in the country, these factors are powerful brakes, in my view. I also expect to see increased anxiety between countries, either due to renewed debt worries within European countries or talk of military initiatives like Israel striking Iran, as discussed in the recent edition of The Atlantic.
I expect to see declining equity prices and rising treasury prices, with potentially a "black swan" event before the end of the year. International equity markets likely react negatively to increased worries in the U.S., offering opportunities to establish positions. The U.S. dollar likely strengthens during this uncertain time as investors flock to perceived safe havens, providing greater purchasing power for domestic investors outside the U.S..
In 2011 I expect much more drastic efforts by the U.S. government to jump start the economy. Potential actions include: (1) Aggressive efforts by the Federal Reserve to keep interest rates low and expand the money supply; (2) Increased political activity centered around both stimulus spending and tax cuts, with deficit hawks pushed to the side; and (3) Growing discussion by investors and media about a fiscal crisis at the state and local level with announcements of service shutdowns (examples from recent news include: furloughing employees in CA, efforts to reduce pension and healthcare costs in Illinois, and closure of transit services in GA). These issues likely encourage foreign investors to reduce their exposure to the U.S., such as China's recent sale of $24 billion of U.S. Treasuries.
While the Federal Reserve likely attempts to keep interest rates low in 2011, at some point market dynamic could overwhelm its efforts if foreign investors decide the U.S. is going down an unsustainable path. This is where it gets scary with the likely popping of the Treasuries bubble, leading to higher interest rates and potentially accelerating inflation. For this reason, I would rather position myself on the inflation side rather than the deflation side going into next year.
Starting in September through the end of the year I expect to initiate positions opportunistically. I expect to over-weight international equity exposure, in general, with greater emphasis in Asia and South America. I plan to invest in variable rate debt to cushion myself from rising interest rates. I also plan to take a position in an inverse Treasuries ETF to capitalize both on the inflating of the Treasury bubble and its potential decline. I will make a few strategic investments in U.S. equities, early on focused on high dividend yield and later on stocks that have been overly sold with solid growth potential. Finally, I will take a couple positions in metals that likely benefit from demand trends outside the U.S.
Note: Do I expect events to unfold according to this script? Of course not. I do expect events close to what I have described, but I've learned that timing is always shorter or longer than anticipated. Thus, I use this post as a way to organize my thoughts and a baseline from which to make adjustments going forward.
Thursday, August 19, 2010
Leading Indicators Suggesting Weakness in U.S. Equities
The Conference Board released its Leading Economic Indicator Index for July, which was 0.1%, missing expectations of 0.2% and slower than improvements earlier in the year. The number suggests a slow recovery, although any further deterioration would likely cause weakness in the equity markets.
Unemployment is typically considered a lagging indicator of economic growth, although the unexpected strength of initial unemployment claims for last weak, coupled with a recent rising trend, would seem to portend future economic weakness. (http://www.bloomberg.com/apps/quote?ticker=INJCJC:IND)
Looking around at other leading indicators, I remain convinced that investors should be prepared for a storm in equities.
The Conference Board:
Gauge of Leading Indicators (July) - Positive 0.1%
Consumer Confidence (July) - Negative 3.9%
CEO Confidence (2Q) - 0.0%
U.S. Google searches:
Durable Goods - negative 9.3%
Real Estate - negative 10.4%
Air Travel - negative 9.0%
Auto Buyers - negative 39% (albeit lapping Cash-for-Clunkers program)
Furniture - negative 9.8%
Trailing 4-weeks Domestic Equities fund flow - Negative $10 billion
Unemployment is typically considered a lagging indicator of economic growth, although the unexpected strength of initial unemployment claims for last weak, coupled with a recent rising trend, would seem to portend future economic weakness. (http://www.bloomberg.com/apps/quote?ticker=INJCJC:IND)
Looking around at other leading indicators, I remain convinced that investors should be prepared for a storm in equities.
The Conference Board:
Gauge of Leading Indicators (July) - Positive 0.1%
Consumer Confidence (July) - Negative 3.9%
CEO Confidence (2Q) - 0.0%
U.S. Google searches:
Durable Goods - negative 9.3%
Real Estate - negative 10.4%
Air Travel - negative 9.0%
Auto Buyers - negative 39% (albeit lapping Cash-for-Clunkers program)
Furniture - negative 9.8%
Trailing 4-weeks Domestic Equities fund flow - Negative $10 billion
Monday, August 16, 2010
Evaluating Lifeboats
There is a joke that if a Disney cruise ship needs to be evacuated the first two people into the lifeboats are Mickey Mouse and Donald Duck. This way they will be present to greet passengers as they board the lifeboats. If the U.S. economy needs to be evacuated will George W. Bush and Barack Obama be there to greet us? After ten years of these two throwing significant monetary and fiscal stimulus at the economy, only to produce a 26% decline in the S&P 500, you begin to look around for lifeboats, and who's in them already.
U.S. Treasuries are one lifeboat into which many have climbed, including last week the Federal Reserve. So many people have jumped in this lifeboat that it appears to float more on a bubble that any intrinsic sturdiness of its own. Maybe it's just the swimmer in me, but when I start seeing strange characters filling up a lifeboat I start considering other options, like swimming for it.
Another popular lifeboat is high dividend yields on rock solid companies in stable industries. So you start sifting through industries like utilities and healthcare for open seats in sturdy lifeboats that should ride through a storm. Fears in this strategy include the size of the impending storm and the design of the lifeboat. Names like National Grid, (NYSE: NGG), Novartis AG (NYSE: NVS) and Sanofi-Aventis SA (NYSE: SNY).
Of course worried investors like boarding a strong reserve currency, historically the U.S. dollar. Given that I am currently 100% in U.S. dollar cash, it has been a painfully obvious choice for someone avoiding risk. From my perspective, I would like to move a fairly large percentage of my investments away from the U.S. dollar when fear is at its highest, which likely builds into October, in my view. My reason is a belief that the monetary and fiscal policies of this country, combined with a 30+ year history of increasingly marginal investment decisions, likely undermines the strength of the U.S. currency over the next 5-10 years. Currencies like the Yen, Euro are obvious for their size, but I am also considering the Pound, Canadian Dollar, Chinese Yuan and baskets of South American and East Asian currencies.
The bottom line is investors should expect flights to safety over the next couple months. If you move now to these lifeboats you can use the strengthening "safe" investments to launch into investments likely to outperform.
U.S. Treasuries are one lifeboat into which many have climbed, including last week the Federal Reserve. So many people have jumped in this lifeboat that it appears to float more on a bubble that any intrinsic sturdiness of its own. Maybe it's just the swimmer in me, but when I start seeing strange characters filling up a lifeboat I start considering other options, like swimming for it.
Another popular lifeboat is high dividend yields on rock solid companies in stable industries. So you start sifting through industries like utilities and healthcare for open seats in sturdy lifeboats that should ride through a storm. Fears in this strategy include the size of the impending storm and the design of the lifeboat. Names like National Grid, (NYSE: NGG), Novartis AG (NYSE: NVS) and Sanofi-Aventis SA (NYSE: SNY).
Of course worried investors like boarding a strong reserve currency, historically the U.S. dollar. Given that I am currently 100% in U.S. dollar cash, it has been a painfully obvious choice for someone avoiding risk. From my perspective, I would like to move a fairly large percentage of my investments away from the U.S. dollar when fear is at its highest, which likely builds into October, in my view. My reason is a belief that the monetary and fiscal policies of this country, combined with a 30+ year history of increasingly marginal investment decisions, likely undermines the strength of the U.S. currency over the next 5-10 years. Currencies like the Yen, Euro are obvious for their size, but I am also considering the Pound, Canadian Dollar, Chinese Yuan and baskets of South American and East Asian currencies.
The bottom line is investors should expect flights to safety over the next couple months. If you move now to these lifeboats you can use the strengthening "safe" investments to launch into investments likely to outperform.
Thursday, August 12, 2010
Starting to get interesting...
The markets are taking a nose dive due to increased worries about a slowdown in the U.S., Great Britain, and China. The U.S. trade deficit was higher than expected, forcing economists to revise projected unemployment levels in the second half of the year. Cisco (NASDAQ: CSCO) reported slower than expected revenue growth and guided below street estimates, raising concerns about the strength technology sector. The U.S. Federal Reserve is resorting to more desperate measures to provide stimulus, or least to avoid applying the brakes. Despite the ridiculously low yields the U.S. dollar is rising as investors seek safe havens.
The Feds' recent announcement it will reinvest funds from maturing mortgage securities into U.S. Treasuries is somewhat disturbing given the historic lows of Treasury yields. How much "bang for the buck" is really provided by this move? Alternatively, does the move ensure yields don't increase this year and provide a brake to the economy?
The good news is this is in-line with what I have been expecting (weaker economic growth and more desperate Fed actions). I think the push/pull between bulls and bears continues for the next couple months but the bearish indicators are exerting more force.
So what am I doing? For now I'm still in cash. I will look for high dividend yielding quality U.S. stocks that are getting sucked down in the overall market. Ideally I'd like to increase my exposure to 10-30% of these stocks by the end of the year. Longer-term I'm looking for opportunities in international markets that appear more attractive with the higher U.S. dollar (and likely weakening dollar once the fear subsides). Ideally I'd like to increase my international exposure to to 40-60% by the end of the year. Finally I plan to take a position in precious metals of 2-10% and keep a relatively healthy amount of dry powder for opportunities in small-to-mid cap companies in 2011.
I love these times.
The Feds' recent announcement it will reinvest funds from maturing mortgage securities into U.S. Treasuries is somewhat disturbing given the historic lows of Treasury yields. How much "bang for the buck" is really provided by this move? Alternatively, does the move ensure yields don't increase this year and provide a brake to the economy?
The good news is this is in-line with what I have been expecting (weaker economic growth and more desperate Fed actions). I think the push/pull between bulls and bears continues for the next couple months but the bearish indicators are exerting more force.
So what am I doing? For now I'm still in cash. I will look for high dividend yielding quality U.S. stocks that are getting sucked down in the overall market. Ideally I'd like to increase my exposure to 10-30% of these stocks by the end of the year. Longer-term I'm looking for opportunities in international markets that appear more attractive with the higher U.S. dollar (and likely weakening dollar once the fear subsides). Ideally I'd like to increase my international exposure to to 40-60% by the end of the year. Finally I plan to take a position in precious metals of 2-10% and keep a relatively healthy amount of dry powder for opportunities in small-to-mid cap companies in 2011.
I love these times.
Friday, August 6, 2010
Structural Issues Causing Weak Jobless Reports?
The July jobs report showed a loss of 131,000 non-farm payroll jobs and only 71,000 private sector jobs created. Furthermore, the June report was revised downward to a decline of 221,0000. While the unemployment rate remained at 9.5%, an increasing number of workers are "leaving the workforce" as unemployment benefits are exhausted and thus potential workers do not file weekly for benefits.
The government is increasingly in an uncomfortable position. Republicans looking to cut taxes further are somewhat neutered due to the Bush tax cuts already in place, and set to expire at the end of the year. Democrats arguing for further stimulus spending are confronted with mixed results from the recent stimulus and rising debt levels. If the politicians continue to argue over these general approaches, I think we're in trouble.
The government needs to start directly confronting what I perceive as the problem, which is structural in nature. In short, too much capital allocated to low returning assets funded by monetary stimulus that aggressively relied on lowering interest rates. In a previous post I highlighted the "race to the bottom" that our overly aggressive monetary policies have encouraged over the past few decades. The argument is that government policies of lowering interest rates to stimulate growth has enabled businesses to avoid pruning under-performing assets and even investing further in relatively low return projects. Obvious examples over the past decade are the dot-com companies and housing, but I believe the issue is widely spread throughout the economy. This low return asset base has built up over 30 years and is a significant drag to the economy since these significant assets need to be written-off.
One program would focus on human capital and one program would focus on invested capital. The human capital-focused program would provide funds for re-training of the workforce. The invested capital-focused program would provide tax credits to companies who actively trim low-yielding assets, either on their balance sheet or who provide services to remove poor performing assets.
Until the country takes more concrete steps to confronting the structural problems, I argue investors should underweight U.S. investments, in general.
The government is increasingly in an uncomfortable position. Republicans looking to cut taxes further are somewhat neutered due to the Bush tax cuts already in place, and set to expire at the end of the year. Democrats arguing for further stimulus spending are confronted with mixed results from the recent stimulus and rising debt levels. If the politicians continue to argue over these general approaches, I think we're in trouble.
The government needs to start directly confronting what I perceive as the problem, which is structural in nature. In short, too much capital allocated to low returning assets funded by monetary stimulus that aggressively relied on lowering interest rates. In a previous post I highlighted the "race to the bottom" that our overly aggressive monetary policies have encouraged over the past few decades. The argument is that government policies of lowering interest rates to stimulate growth has enabled businesses to avoid pruning under-performing assets and even investing further in relatively low return projects. Obvious examples over the past decade are the dot-com companies and housing, but I believe the issue is widely spread throughout the economy. This low return asset base has built up over 30 years and is a significant drag to the economy since these significant assets need to be written-off.
One program would focus on human capital and one program would focus on invested capital. The human capital-focused program would provide funds for re-training of the workforce. The invested capital-focused program would provide tax credits to companies who actively trim low-yielding assets, either on their balance sheet or who provide services to remove poor performing assets.
Until the country takes more concrete steps to confronting the structural problems, I argue investors should underweight U.S. investments, in general.
Tuesday, August 3, 2010
Stocks are Rising but What about Economy?
Stocks have been floating higher as investors bask in a relatively healthy summer earnings season and slower summer markets produce a less tense view about the world. I guess the recent beach weather has mellowed investors. Just like the recent shark sightings off Cape Cod, I feel a need to raise a flag of caution. A couple recent data points are warning us about potential treacherous times in the fall, likely October if the market keeps rising and history is any guide.
Slower growth for new factory orders in July, as reported by The Institute for Supply Management, suggest the recent health in the economy was due more to replenishing inventories than a more sustainable recovery. The index was 53.5, still in expansionary territory but declining from levels recorded earlier in the year. The August data point to be published at the beginning of September likely is the first data point investors focus on post summer vacations. Anything below 50 likely gets an immediate downward response in the equity markets, 50-55 likely produces a bit of fear going into October, and above 55 provides investors with some measure of relief.
The Federal Reserve is now apparently considering re-investing money back into the bond market once previously purchased mortgage and treasury bonds mature. These investments in the bond market over the past couple years were unusual and were originally an effort to stimulate the economy. The program has ended and thus a potential re-investment strategy is a change in outlook. Considering many investors consider the bond market somewhat over-priced (relatively low yields) this potential action seems to register a little higher on the desperation scale of monetary stimulus. As mentioned in an earlier post, I would not be surprised to see the Federal Reserve take more non-traditional actions as it attempts to stimulate the economy. Assuming the slowing new factory order data is foreshadowing a slower economy, I would expect the Federal Reserve's action to continue to move up the desperation scale. These efforts likely result in more volatility.
On a positive note, having spent the last few weeks outside of the U.S., I have been pleasantly surprised by the relative health of other countries. At this point I think investors should be focusing more on South American economies, Canada, and a few emerging markets in Europe and Asia. In addition, silver appears interesting at this level, if for no other reason than a more inexpensive way to diversify the portfolio without buying historically high gold prices.
Slower growth for new factory orders in July, as reported by The Institute for Supply Management, suggest the recent health in the economy was due more to replenishing inventories than a more sustainable recovery. The index was 53.5, still in expansionary territory but declining from levels recorded earlier in the year. The August data point to be published at the beginning of September likely is the first data point investors focus on post summer vacations. Anything below 50 likely gets an immediate downward response in the equity markets, 50-55 likely produces a bit of fear going into October, and above 55 provides investors with some measure of relief.
The Federal Reserve is now apparently considering re-investing money back into the bond market once previously purchased mortgage and treasury bonds mature. These investments in the bond market over the past couple years were unusual and were originally an effort to stimulate the economy. The program has ended and thus a potential re-investment strategy is a change in outlook. Considering many investors consider the bond market somewhat over-priced (relatively low yields) this potential action seems to register a little higher on the desperation scale of monetary stimulus. As mentioned in an earlier post, I would not be surprised to see the Federal Reserve take more non-traditional actions as it attempts to stimulate the economy. Assuming the slowing new factory order data is foreshadowing a slower economy, I would expect the Federal Reserve's action to continue to move up the desperation scale. These efforts likely result in more volatility.
On a positive note, having spent the last few weeks outside of the U.S., I have been pleasantly surprised by the relative health of other countries. At this point I think investors should be focusing more on South American economies, Canada, and a few emerging markets in Europe and Asia. In addition, silver appears interesting at this level, if for no other reason than a more inexpensive way to diversify the portfolio without buying historically high gold prices.
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