FINANCIAL REVIEW

What? Me Worry?

Sinclair Noe — November 19, 2014

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

DOW – 2 = 17,685
SPX – 3 = 2048
NAS – 26 = 4675
10 YR YLD + .03 = 2.35%
OIL – .51 = 74.61
GOLD – 14.40 = 1184.10
SILV – .06 = 16.23

The Federal Reserve’s most recent FOMC meeting was October 28th and 29th; after the meeting they issued a statement saying that QE3 was finished; they painted a fairly positive picture off the economy to confirm their decision. Fed Chair Janet Yellen and her central bank colleagues last month focused on improvements in the labor market when they announced an end to their stimulative bond purchases. They also said that the risk of inflation remaining persistently below their goal had ebbed. Today, they released the minutes of the FOMC meeting and we get some better understanding of their thoughts. No bombshells, not much that was not expected.

Policy makers last month “pointed to a somewhat weaker economic outlook and increased downside risks in Europe, China, and Japan,” in addition to a stronger dollar. There were concerns “that if foreign economic or financial conditions deteriorated further, US economic growth over the medium term might be slower than currently expected.” There was some debate over whether to acknowledge the weakening global economy; the general feeling was that the effects weaker growth overseas would “likely be quite limited,” and that any mention of global weakness could send an unwarranted signal of pessimism. Put on a happy face. Include a few smiley face emoticons and don’t scare people. Fed staff cut their estimates for near-term U.S. economic growth, and policymakers debated both the impact of slowing growth overseas and possible limits on their ability to respond if needed.

The FOMC meeting was in late October and the US stock markets were just bouncing back from a nasty selloff, and it appears the Fed showed appropriate patience by not mentioning what turned out to be a fairly minor pullback. Or maybe they were just following the Alfred E. Neuman philosophy of “What, me worry?” economics. Whatever they thought, they didn’t want to give the impression the Fed would backstop the stock market whenever there was a minor case of turbulence. And it turns out the stock market didn’t need a backstop.

Indeed, JPMorgan has now looked at the market, and determined the recent rally has gone too far, too fast, downgrading the US stock market, reversing its overweight call to underweight as valuations relative to Europe had “turned outright expensive.” The firm upgraded the euro zone to overweight from underweight, believing the region “is due a period of outperformance vs the U.S.,” with European banks primed to support the region.

The sluggish pace of inflation is displacing unemployment as the primary reason the Fed is not ready to start raising interest rates. The big concern seems to be that there could be a downward shift in “longer-term inflation expectations”; in other words, disinflation, low-flation, of maybe even deflation. A study released Monday by a San Francisco Fed economist says that inflation might not reach 2 percent until “after the end of 2016.” The Fed is not really in a good position to deal with a deflationary environment. Most central banks’ efforts to deal with deflation involve “pushing on a string.”

Following the release of the minutes, US short-term interest-rate futures traders were still betting on a first Fed rate hike by September next year. The Fed next meets in mid-December, and officials will issue updated economic projections.

So, if there is a disinflationary or deflationary environment, what would that mean for investors? The initial impulse would be that it is bad; there are many ways in which deflation can destroy an economy, but wait a minute; imagine lower prices for commodities, lower prices for imports, and a stronger dollar creating more disposable income, and it sounds like you have the ingredients for growth.

Of course, the other way to grow the economy is by growing it; adding jobs and a modestly inflationary environment in which wages are improving along with productivity, the wages are spent, creating demand, which creates jobs, etc., etc., in a virtuous cycle. More than five years into the economic expansion, we might finally be seeing signs of a pickup in pay that has long eluded American workers are starting to emerge.

Wages and salaries climbed last quarter by the most since 2008 as a dwindling number of unemployed per job opening approached a tipping point. Employment costs over the past two quarters rose 0.7 percent, according to figures from the Labor Department. The gain in the third quarter was led by a 0.8 percent advance in wages and salaries for civilian workers that was the biggest since the second quarter of 2008. The jobless rate has dropped by 1.4 percentage points over the past year to reach a six-year low of 5.8 percent in October, and the number of jobs waiting to be filled in August and September were highest since early 2001. About two jobless workers were pursuing each opening in September, the fewest since early 2008.

And with rising profits and sales per employee, some companies have a cushion to boost compensation. Wage growth is beginning to bubble up. The labor market is now tightening to the point where we are beginning to see some stronger wage gains. Most of the wage gains are geographically concentrated or contained to certain industries, and there is still plenty of slack in the labor market. The long-term unemployed and the underutilized, or people working part-time allow companies to add staff without offering bigger paychecks.

Evidence of a job-market turnaround is showing up in reports such as surveys conducted by the Institute for Supply Management, whose non-manufacturing members reported that labor was one of the commodities rising in price and in short supply in each of the past two months. That hasn’t happened since at least 2007. Payroll processing company ADP also reported that the hourly wage rate of the 24 million workers at the firm’s clients rose 4.5% last quarter; that ADP number is probably much bigger than any government numbers we’ll see for some time, but it does point in the direction of wage growth, not running ahead but moving forward.

The housing market relies on people who have jobs, and today we got another indicator from the Commerce Department report showing starts for single family homes rose for a second straight month in October and building permits neared a 6-1/2 year high. Groundbreaking for single-family homes, which account for more than two-thirds of the market, increased 4.2 percent to a seasonally adjusted 696,000-unit annual pace, the highest since last November. At the same time, permits for single- and multi-family housing jumped 4.8 percent to a 1.08 million-unit pace, the highest since June 2008. It also was the second straight monthly gain. A separate report from the Mortgage Bankers Association showed applications for loans to purchase homes surged last week as low rates lured potential buyers.

It will be interesting to see what happens to these figures next month, in light of the crazy cold winter weather we’re seeing across much of the nation. Here in Arizona, the weather is fantastic, but much of the country is suffering, and just in case you call friends or relatives back East, it is not considered polite to gloat about our good weather.

Lower gas prices are generally seen as a boost for the economy. Economists calculate that households have already saved about $100 billion so far, and retailers are hoping that will translate into holiday sales. A new Ipsos/Reuters poll finds almost 60 percent of survey respondents remain cautious about spending because of “economic uncertainty”; in other words, stagnant paychecks, higher food prices, unemployment and underemployment. Americans learned to spend less during the recession, and they’re not quitting those habits quickly. The savings rate rose slightly in September.

The number of shoppers expecting to spend less this year than last outweighed those who expected to spend more in every category in the Reuters poll, except food, which was nearly balanced. Some 30 percent expect to spend less on electronics, 37 percent less on jewelry and about a quarter less on clothes and toys. Americans also have learned in recent years to find the best deals on the internet. Nearly two-thirds of retailers plan to offer more discounts and promotions this year than last.

President Obama will speak to the nation in a prime-time address tomorrow, asserting his authority to protect up to five million undocumented immigrants from deportation. In a video posted on the White House website, Obama says: “Everybody agrees that our immigration system is broken. Unfortunately, Washington has allowed the problem to fester for too long. What I’m going to be laying out is things that I can do with my lawful authority as president to make the system work better even as I continue to work with Congress and encourage them to get a bipartisan, comprehensive bill that can solve the entire problem.”

The televised address will be at 6PM MST. It is expected the executive action will remove the threat of deportation for the parents of children who are citizens or legal permanent residents of the United States. The action will also provide new guidance for the nation’s immigration enforcement agents and revamp the legal immigration system to provide more opportunities for high-tech workers from other countries. As many as four million immigrants living in the country illegally will get a reprieve from deportation under a new program similar to one that already protects undocumented people who were brought to the country as children. The immigrants must have lived in the country for at least five years and have no criminal record. An additional one million people would get protection through other parts of the president’s actions.

White House officials have said that the president remains open to signing a legislative overhaul if Republicans relent, but that his patience has run out. By taking action now, Mr. Obama is daring the Republicans, and they may take up the challenge, not with immigration legislation but with challenges on other legislation, such as government spending, or through lawsuits against the president.