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

Fed Takes Action

As the economy has grown stronger, the Federal Reserve has been discussing when to reduce its bond and mortgage purchases. For about 15 months, the Fed has been purchasing about $85 billion each month and has acquired approximately $3 trillion in these investments. The purpose was to add liquidity to the economy, which resulted in lower mortgage interest rates, lower long-term bond interest rates and a booming stock market. The Fed indicated this afternoon that they will taper off these purchases by about $10 billion, bringing them down to about $75 billion monthly. Tapering will reduce the flow of cash from the Fed but will also allow them to adjust upward easily if the economy shows signs of souring. If tapering does not disturb the economy, it will likely be followed by additional cuts until all purchases are stopped. The long-term impact of this change will likely be an increase in longer-term interest rates and slowing of the rise in stock prices.  I had not personally expected the change until March of 2014, once Janet Yellen was in place as the new Fed Chairman. The change is likely to be the last major action by the current Fed Chief, Ben Bernanke. At the same time that they announced the tapering of purchases, the Fed also indicated that short-term rates would remain close to zero until after the unemployment rate goes below 6.5%.  This information means that short-term rates will be likely to stay at zero until late 2015 or early 2016.

Ed Mallon

Market Turning Down

During the past number of market sessions, we have seen some profit taking on stocks and repositioning of bonds, which has moved the stock market down. The result is confusion on the economic front. The good news, announced on Thursday, was that in the third quarter the economy grew at a rate of 3.6%, rather than the 2.8% originally reported. Business inventories, at $116.6 billion--the largest accumulation of inventories since the first quarter of 1998--accounted for most of the growth. This growth is in sharp contrast with domestic demand that rose only 1.8% rather than the expected 2.1%. As a subplot, consumer spending dropped to 1.4%, the lowest since the fourth quarter of 2009. Retail spending, so far in the fourth quarter, does not seem to be picking up as we go into the biggest shopping period of the year. Retailers may have to take major markdowns before the holiday season is over, to align inventories with consumer spending. Corporate profits, after tax for the third quarter, dropped to 2.6% from 3.5% in the second quarter. If heavy discounting of inventories takes place, corporate profits may drop further. Expectations of advancing corporate profits have kept the recent stock rally going. The reality of what might happen to corporate profits is setting in and moving the market downward.

All is not lost. It appears this will be a correction and not a bear market. One of my favorite indicators is the number of initial jobless claims. I have not reported on that in a while. Last week, jobless claims were at 298,000, the lowest number we have seen in years, and the third weekly drop, which is also impressive. Not long ago, I was wishing for the claims to drop below 400,000! With all of this information, I am maintaining my position that the Federal Reserve will not reduce bond purchases before March of 2014. The liquidity level of the economy should remain constant, which is good.  The economy surprised experts in the second quarter, growing more than 2% after original estimates of 1%. Again in the third quarter, the economy grew at 3.6% after the original estimate of 2.8%. Who knows? Perhaps it will do so again in the fourth quarter.

Ed Mallon