Lost Momentum

The U.S. Government recently released results of economic growth for the first quarter. The report indicated that the economy shrank by 1%. While the expectation had been for slow growth, this significant negative reversal signaled a loss of momentum from the fourth quarter of 2013. The impact is visible in the housing industry, where both existing home and new home sales slowed. One would think that this information would result in a negative stock market reaction, but the S&P 500 soared to a new high. At the same time, the slowing economy has resulted in the 10-year Treasury Bond dropping in yield, from about 3% to 2.44%, with an increase in the value of underlying bonds. This change in the Treasury values has also impacted high quality bonds, with yields decreasing and values rising. Taken to another level, this lowering of interest rates has pushed the mortgage interest rates back down, making it less expensive to buy a home. The slowing momentum of the first quarter would appear to have a very positive impact on the second quarter. We are beginning to see home sales, consumer spending and manufacturing increase. For these reasons, stocks have climbed. Clearly, the loss of momentum from the first quarter, due primarily to bad weather, has turned around. We will now have to wait and see if momentum can be regained.

Ed Mallon 

Demographics

The current economic picture is one of slow growth. The economy is moving in fits and starts but lacks momentum. The S&P 500 closed yesterday at 1885. At the end of 2013, the S&P 500 closed at 1848, meaning it has risen about 2% for the year to date. This certainly is not the robust market of 2013. Many reasons might account for slowing the growth in stocks, but overall, I’d say the stock market got ahead of itself.

When we came out of the 1982 recession, the growth in GDP was 7.5%, with the next two recessions recovering at a more modest 5.6% and 5.2%. Nominal GDP growth is just 3.7% during the current expansion. This slow growth is not just in the U.S. but is occurring in Europe, Japan and China, to name a few.

Perhaps something else is at work that is being overlooked. From 1968 to 1985, the population growth in the U.S. was 2% annually. During this same period, the growth in GDP was 4%. From 1985 until 2000, the population grew 1% and the GDP grew 3%. Since 2000, the approximate population growth is 0.6% and the growth of GDP, overall, is just above 2%.

I believe there is a correlation between population growth, the aging of the population and the growth of GDP. The United States has benefited over the years from the constant influx of immigrants into the U.S. This influx brought young people who had families, and brought down the average age in the U.S. as the balance of the population aged. This has not been the case in Russia, where the birth rate has been low and the mortality rate is high. Europe also suffers from this problem, except for Germany, which took in the East German population. Japan and China both have aging populations.

In the 1980s and 1990s, the U.S. had wide swings in economic growth. With our aging population, we are now experiencing a period of fewer swings and longer-term growth prospects. While the current growth is not up to previous levels, it will possibly last for a much longer time, say the next 5 to 8 years. The U.S. is part of an international community now, so the growth possibilities of the U.S. will be moderated by the lack of growth in some developed and developing countries. This period will not show spectacular growth, but it should be good for the U.S. economy. I’ll talk more about the impact of demographics at another time.

Ed Mallon 

Fear of No Growth

Since the beginning of this year the stock and bond markets have been rather subdued. In 2013 the general outlook was that the economy was picking up momentum. The increase in business activity, business profits and a shrinking of government spending was seen leading the economy back to “normal.”  The results for the year were in many ways more robust than what had been expected. More jobs were created, new jobless claims dropped and the unemployment rate fell. As we came into the first quarter of 2014 there was concern that economic growth was lagging. Jobs were still being created, new jobless claims were still down and the greatest number of people since the first quarter of 2008 were employed. The problem with all of this was that the sense of “growth” in many sectors of the economy wasn’t there in the first quarter. The S&P 500, as of this writing, is up an anemic 0.0% for the year. As we await results from corporations for the first quarter, it seems likely stocks will fall further. At the same time, the slow growth of the economy has made bonds stronger. There is a reduced sense of worry about inflation, business earnings are good and the Federal Reserve’s pull back in the buying of bonds and mortgages has not disrupted day to day bond trading. Overall what we are seeing is stability of the economy but with no real growth impetus. It appears that bad weather in the first quarter, coupled with no growth in Europe is what slowed down the economy. As we enter the second quarter we may begin to see signs of a turn around. The European Union is taking steps to grow their economy as Japan does likewise. These moves along with better weather and the growth that is taking place in the U.S. may be enough to get the momentum going again. For now, dividend paying stocks and interest bearing bonds are what’s considered best!

Ed Mallon 

Cheap Natural Gas

Today, in the second section, page 2, of the Wall Street Journal (WSJ) an article appeared about what cheap natural gas means to the U.S. economy. For some time I’ve thought that the abundant gas in the United States would result in greater manufacturing coming here. I had not considered the impact of construction from this change. The WSJ reported that the chemical industry alone is accounting for more than $100 billion of new construction in the gulf coast states, with another $125 billion anticipated. This business investment is by the U.S., Germany, Canada, and other countries. “From 2010 to 2012, energy-intensive manufacturing sectors added more than 196,000 U.S. jobs and increased real sales by $124 billion.”  This new growth is not just in the manufacturing plants moving here and being built, but in the construction, steel and other fabrication industries related to construction. Increasing construction costs, from the pressure on a limited supply of labor and materials in the Gulf Coast, may bode well for other parts of the country with less expensive construction costs. This should have a positive long-term impact for U.S. construction and job formation.
Ed Mallon

The Rhythm is Broken

Sometimes the stock market achieves a nice rhythm. We have recently seen such a period. After a poor start to the year, good economic news prevailed and the markets increased. Today in Reuters News Service, I noted a number of very good traits that should continue the momentum of growth in the economy. Factory orders rebounded from an eight-month low. Automobile sales increased. A gain in construction spending was reported, despite unseasonably cold weather! Consumer spending increased, with spending on services up 0.9%, the biggest gain since October 2001. All good news, and yet, as of this writing, the stock market is down more than 1%. The break in the rhythm is because of the uncertainty surrounding Russia’s military intervention into Ukraine. As I have stated in the past, “the markets do not like uncertainty.” We have no way to dispel this uncertainty, and this is why we have a diversified portfolio. In times like this, investors tend to drive up the value of more defensive issues, such as bonds. I will be watching the situation in Ukraine to determine the best investment course of action. For now we will make no changes. Ed Mallon

A Correction?

As I have reported recently, it is not unusual for the stock market to have a correction after a lengthy time on the rise. Yesterday we saw that a correction can still be painful. The stock market dropped a little over 2% yesterday, meaning that anyone in the market at that time lost money. Although you are a long-term investor, that is your money. A correction is usually about a 10% drop in the value of stocks. This usually sets the stage for another increase in value. A day like yesterday is generally followed by two to three days of the market rising before it again tests the downside. 

I believe that equity investments will bring us rewards in the future as the economy grows and energy becomes increasingly available.  The road to those rewards will be bumpy, such as what we saw yesterday.

Ed Mallon

Doing its own Thing

Last year, equities were up significantly. Some wondered what would happen this year. As I am writing this, the S&P 500 was back to the December 19th level of 1805. On January 15, 2014, the S&P hit a record high of 1848.  Interestingly, this record high for 2014 is the same as the closing point of the S&P at the end of the last year, meaning that the S&P is down about 2.5% since the end of 2013. Given that the stock market was up 28% last year, this change is barely a blip on the radar screen. So where is the money that is leaving the stock market going? Bonds are up in value! As I always say, the three rules of investing are: diversify, diversify, diversify. You never know which asset class is going to do the best. As an investor, the idea is not to hit home runs but to make money. After increasing so much last year, a correction, with the market dropping about 10%, would not be unusual. I believe that, in the long run, stocks will do very well.
Ed Mallon

Non-correlation

Non-correlation of investment assets may seem to be complicated, but it is very important to the long-term success of an investment portfolio. To understand non-correlation, we must first understand what we mean when assets are correlated. Investment assets are referred to as being highly correlated when they show a tendency to vary together. For example, U.S. stock classes--large, medium and small-- tend to increase and decrease in value together. For many years, large international stocks were not considered to be correlated to U.S. stocks, but they are now 92% correlated. Bonds are not correlated to stocks. Bond groups--investment grade corporate bonds, U.S. Treasury bonds and municipal bonds--tend to be highly correlated. Stocks and bonds are not correlated and therefore each moves in its own manner. The importance of including non-correlated assets in your investment portfolio is to reduce investment risk. Bonds, stocks, real estate, emerging market investments, and commodities are non-correlated. By mixing these various non-correlated asset classes, your portfolio is not as likely to be whipsawed, up or down, by the volatility of one particular class of assets. While this strategy is helpful in most instances, it is not foolproof. On the other hand, including asset classes that are non-correlated doesn’t prevent them all, or most, from moving up or down at the same time. In 2008, we saw an example of non-correlated assets all moving down together, as the U.S. and world economies went through a terrible economic period. This is the exception and not the norm, but illustrates what can happen. For this reason, I believe that a static portfolio, one that sets an allocation of non-correlated assets that does not change, can be detrimental to your investment wealth. Depending on the state of the economy and other relevant information, raising or lowering the percentages of various non-correlated assets can be useful, and is an active asset management style.

Ed Mallon