As we approach the half way point for 2011, the complexion of the equity markets’ performance appears to have changed… or has it?
Sure we have hit a soft patch as the events of last quarter In Japan combined with higher energy and food prices have slowed the economy. While I believe this to be temporary and the economy re- accelerate later this year, the market’s reaction to the slowdown and the recent bout with sovereign debt concerns has created opportunities for specific ETF’s that should perform even if the economy and markets don’t recover.
First to mind is the high yield bond market (iShares iBoxx High Yield Corporate Bond Fund, JNK). High yield has benefited greatly from the general improvement in credit, demand for yield and economic recovery over the past two years. It’s clear the “soft patch” has resulted in an equity valuation adjustment, but the strong downside correlation and beta of HYG to the equity markets is greater than historical averages. The sovereign debt concerns have exacerbated this move as well, however, the strong profitability and cash levels of corporations backing these bonds equates to a magnitude of decline move in our eyes that is unwarranted. In fact we are at a point where the yield (HYG currently yields approximately 7.6%) is greater than the average decline in this sector. If HYG returns to its 5/31 closing price, this is an additional 3% kicker, but you don’t need the market to move to make money.
Another ETF play is the UUP (Powershares DB US Dollar Index Bullish Fund), a long US dollar play. The dollar has tended to rally over the past three years when stocks drop on a flight-to-quality move, providing a nice diversification. Further, if the decline in US stocks continues as a result of Euro-zone credit issues, the dollar is the likely benefactor. Additionally, if rates start to increase due to growth acceleration, the US the dollar will likely benefit as well. This would only be benefited more by austerity measures in the US.
Now looking to ETFs with direct exposure to equities, most have found tough footing on economic sensitivity and geopolitical issues of recent. Health care (Health Care Select Sector SPDR Fund, XLV) has offered investors some attractive qualities for the current market environment. XLV has been one of the strongest sectors this year, still holding gains over 12% for the year, while offering a yield to investors near 2%. In the month of June, while the majority of broad based indices have declined 4.5% – 6%, XLV has declined by half of that at slightly less than 2.5%. This is a sector that many worried about suffering from a political standpoint as the healthcare bill and other political rhetoric moved around Washington. However, to the contrary, this has been one of the most consistent performers through an up and down year,
These ETF’s we discussed above should do well for the portfolio and provide stability and diversification even if the market continues its recent decline. But from my perspective the recent weakness is “temporary”, and here’s why:
Many are looking at recent data such as GDP and jobless claims to support a slowdown that is a precursor to another recession. But remember that jobless claims are a measure of those who are not working. We prefer to look at monthly payrolls that measure the amount of people who are working (and contributing to the economy). The number of people working each month is increasing at around 200,000 and has been for the past year or so. In fact, one of the better non-farm payroll numbers we had was for April, the same month that saw unforeseen upticks in jobless claims up as high as 478! The “horrible” non-farm number for May was actually a positive number, meaning we ADDED jobs to the economy…again. Also, GDP was revised up to 1.9% again another POSITIVE data point. Let’s not shoot a nickel because it’s not a quarter.
The markets can fluctuate during any 30-60 day period but the trend for the 2-6 quarters ahead generally follows the employment and output trend. After all the market is up over 20% from this time last year so some consolidation/correction is to be expected. The events of Japan and the higher oil prices from last quarter are having a temporary impact on the economy.
But make no mistake the economy is growing! Corporate profits are at record levels, personal income is at record levels, tax receipts are up 55% from a year ago and the S&P is trading at the lowest multiple to earning in over 26 years. While the market may still go lower from here it would be a mistake to suggest a recession is coming. In fact, growth is more likely to accelerate later this year and the more probable direction for stocks in the 12 months ahead is higher
Saturday, July 9, 2011
Sunday, July 3, 2011
Good News! Inflation!
Written by John Eckstein- Director of Research at Astor Asset Management, LLC
While we all wring our hands about inflation and grim-faced, serious-suited bankers tisk, the fact that we have had an uptick in inflation in 2011 is good news. That and the prospect of a bit more is putting the United States into a position where job creation – and demand creation – is more likely. To explain why, I am going to call upon our trusty friends, supply and demand.
Economists usually think about supply and demand balancing on a graph that shows the quantity of a good demanded on one axis and the price of the good on the other with the price representing what would be obtained in the marketplace and sampled at monthly intervals perhaps, showing at each price where supply and demand met: this many dollars for that many cookies. The chart shows one representation of the US labor market with total labor (in terms of total hours worked) on the horizontal axis and the real (or inflation-adjusted) wage on the vertical axis. Recall what happened at the end of 2008. Many, though not all, economists would describe that period as one characterized by a sharp drop in aggregate demand, that is on the whole the US decided to consume a lot less of some things (houses in Las Vegas for example) and somewhat less of almost everything. As consumers demanded less, producers made less and thus there was less demand for labor. Now if the demand for something goes down: why then our ancient faith should teach us that the price should usually drop as well. Look at the red squares on the chart though: they represent the period 2009 to date and you will see that the real wage – the price of labor – increased over this period.
This scenario seems odd. Of course employees did not find a note on their paystub saying: “business is terrible, have a raise”, but the CPI dropped substantially with no change to the trend in nominal wages – causing inflation adjusted wages to increase – and until the end of 2010 both prices and wages moved together, keeping real wage at its new, higher level. Now it’s a bit of a puzzle why wages wouldn’t fall during a recession. The same thing happened, though not to the same extent, in the 2001 recession but wages fell, as you would expect, in the 1990-91 recession. Logic dictates that if more workers are to be hired they must be hired at a wage firms find attractive but there seems to be a bit of disconnect between the real world and the ultra-rational economic factors our models posit.
Whatever the cause of the increase in real wages, with inflation rising faster than wages over the last few months, we have begun to see some progress toward moving wages nearer to the level they were before the recession started. Call it half way there. At this point we are in the unusual situation of hoping for a bit more inflation and sooner rather than later. Enough inflation, that is, to move the real wage down to induce firms to hire more workers (thus increasing demand and – hopefully – moving the real wage back up again but for the “right” reason) but not high enough to force the Fed to hike rates prematurely. Incidentally, increasing inflation somewhat would also reduce the real interest rate which is good for getting money into the hands of firms who can invest it.
According to the Fed’s semiannual monetary report to Congress from this winter, increasing inflation to more normal levels was one of the goals of the second round of quantitative easing undertaken by the Fed which is due to end this month, Interestingly, one idea which keeps coming up in discussions of Fed thinking is inflation targeting, where the fed explicitly aims at a target for inflation, with a balanced approach of reacting to inflation either over or under the target.
Of course the real wage is not the only thing going wrong with the US economy and it is easy to overdo it with inflation. I believe, however, the recent moves are moving the US labor market towards a higher employment equilibrium.
John Eckstein is Director of Research at Astor Asset Management, LLC
While we all wring our hands about inflation and grim-faced, serious-suited bankers tisk, the fact that we have had an uptick in inflation in 2011 is good news. That and the prospect of a bit more is putting the United States into a position where job creation – and demand creation – is more likely. To explain why, I am going to call upon our trusty friends, supply and demand.
Economists usually think about supply and demand balancing on a graph that shows the quantity of a good demanded on one axis and the price of the good on the other with the price representing what would be obtained in the marketplace and sampled at monthly intervals perhaps, showing at each price where supply and demand met: this many dollars for that many cookies. The chart shows one representation of the US labor market with total labor (in terms of total hours worked) on the horizontal axis and the real (or inflation-adjusted) wage on the vertical axis. Recall what happened at the end of 2008. Many, though not all, economists would describe that period as one characterized by a sharp drop in aggregate demand, that is on the whole the US decided to consume a lot less of some things (houses in Las Vegas for example) and somewhat less of almost everything. As consumers demanded less, producers made less and thus there was less demand for labor. Now if the demand for something goes down: why then our ancient faith should teach us that the price should usually drop as well. Look at the red squares on the chart though: they represent the period 2009 to date and you will see that the real wage – the price of labor – increased over this period.
This scenario seems odd. Of course employees did not find a note on their paystub saying: “business is terrible, have a raise”, but the CPI dropped substantially with no change to the trend in nominal wages – causing inflation adjusted wages to increase – and until the end of 2010 both prices and wages moved together, keeping real wage at its new, higher level. Now it’s a bit of a puzzle why wages wouldn’t fall during a recession. The same thing happened, though not to the same extent, in the 2001 recession but wages fell, as you would expect, in the 1990-91 recession. Logic dictates that if more workers are to be hired they must be hired at a wage firms find attractive but there seems to be a bit of disconnect between the real world and the ultra-rational economic factors our models posit.
Whatever the cause of the increase in real wages, with inflation rising faster than wages over the last few months, we have begun to see some progress toward moving wages nearer to the level they were before the recession started. Call it half way there. At this point we are in the unusual situation of hoping for a bit more inflation and sooner rather than later. Enough inflation, that is, to move the real wage down to induce firms to hire more workers (thus increasing demand and – hopefully – moving the real wage back up again but for the “right” reason) but not high enough to force the Fed to hike rates prematurely. Incidentally, increasing inflation somewhat would also reduce the real interest rate which is good for getting money into the hands of firms who can invest it.
According to the Fed’s semiannual monetary report to Congress from this winter, increasing inflation to more normal levels was one of the goals of the second round of quantitative easing undertaken by the Fed which is due to end this month, Interestingly, one idea which keeps coming up in discussions of Fed thinking is inflation targeting, where the fed explicitly aims at a target for inflation, with a balanced approach of reacting to inflation either over or under the target.
Of course the real wage is not the only thing going wrong with the US economy and it is easy to overdo it with inflation. I believe, however, the recent moves are moving the US labor market towards a higher employment equilibrium.
John Eckstein is Director of Research at Astor Asset Management, LLC
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