April 2011
April 29, 2011 08:00 p.m.
A Turning Point in the Economy
The economy is nearing a turning point, and few investors seem to realize it. We’ve been expecting it for a while and have our portfolios well-positioned for it. But as the point draws near, we’re becoming more cautious with the portfolios. The sell signals have been tightened, and I’m keeping careful watch on several funds for signs that it’s time to sell them.
Here’s why we’re nearing a turning point.
The economy and markets surged largely on stimulus since March 2009. The stimulus is from both fiscal and monetary policy. In response to the stimulus, asset prices (other than real estate) rose, the economy returned to positive growth, and the unemployment rate fell. In emerging economies, economic growth has been strong, with GDP in many of those countries reaching above the 2007 peaks.
The stimulus now is being withdrawn or phased out. The Federal Reserve this week confirmed that it plans to end the QE 2 policy at the end of June. It doesn’t plan to shrink its balance sheet by selling the bonds accumulated the last two years, but it also doesn’t plan to buy new bonds.
At the same time, the effects of the fiscal stimulus is nearing its peak. The income tax cuts are in place, and their effects have been felt. The federal spending designed as stimulus is mostly ending.
The U.S. also benefited greatly from stimulus in the emerging markets. When we analyze corporate earnings and revenue growth and also sources of U.S. GDP growth, we see that much of the growth came from U.S. companies selling to foreign markets, especially emerging markets. The emerging economies are throttling back on their stimulus. They’re so worried about inflation that they’re taking steps to reduce economic growth. I expect they’ll need to take stronger steps later this year and early in 2012.
The hope with the stimulus was that it would enable the private economy to recover and take over with sustainable growth after the stimulus faded. For that to happen, private credit would have to grow.
So far, there are very few signs the private sector will maintain the recent modest growth rate on its own. Private credit growth still is at low levels, and much of that credit appears to be federally backed or guaranteed credit, such as student loans. Consumer spending has been growing less than consumer income, so consumers aren’t borrowing to buy things. And a lot of the income growth is supported by the government.
Without a change from this pattern, the economy’s growth will be dependent largely on the growth of household incomes. That growth is modest and likely to remain so. Growth in emerging economies will help the U.S. economy, but we can expect that growth rate to slow over the next year.
That’s why I’m cautious and see a turning point ahead. A number of analysts are optimistic because stock indexes have been rising to post-crisis highs. I believe that is momentum from the previous stimulus measures. I’m looking ahead and am concerned about what will happen to that trend once the stimulus fades. That’s why we’re still cautious, balanced, and diversified in our portfolios and will be watching markets closely as the rest of the year unfolds. The economy appears to have enough momentum to continue growing modestly at least through the end of the year. But that could change, and markets often anticipate economic changes by a few months.
April 8, 2011 02:00 p.m.
Budget Battles and Your Money
Today’s budget battle in Washington doesn’t mean much in the long term. They’re discussing a very small percentage of the total budget. They’re also discussing the current year’s budget, something that should have been enacted last summer or fall. The budget debate that really matters involves the next year and following years. This pits the budget proposed this week by House Budget Chairman Paul Ryan versus a continuation of current spending policies.
It doesn’t matter what your political idealogy is. At this point, what matters is arithmetic. Federal government spending can’t continue at current levels, and it certainly can’t continue at current levels plus increases for inflation and spending programs others want. Significant changes have to occur.
For a sample of the potential futures for the U.S., take a look across the Atlantic to Europe.
There are only a few actions an overly-indebted country can take. It can change fiscal policies. That means cutting spending, not the growth of spending but actual cuts in spending. It can raise taxes. Or it can take a combination of those actions.
It also can seek a restructuring of its debts by negotiating with creditors. Restructuring can be outright forgiveness of the part of the debt. Or it can mean a change in the terms, such as reducing interest rates or extending the payment period. Governments, of course, don’t have to negotiate. They can announce new debt terms.
Another option is to effectively default on part of the debt by pursuing inflationary policies. The debt is paid back in a currency with reduced purchasing power.
The final possibility is outright default. This is the least likely, because most governments want to be able to borrow in the future and are concerned they won’t be able to if they default.
Across the ocean, the U.K. is a sample of a country that’s choosing the first option of austerity. It’s probably about a year ahead of the U.S. It became concerned about inflation and runaway debt. Since mid-2010, the U.K.’s been tightening monetary policy and reducing government spending. The result is the reason most governments don’t want to go this route. The U.K. economy is noticeably slowing. There are fears of a new recession and rising unemployment. The government is unpopular.
The peripheral economies of Europe made a few small efforts in this direction. Greece, Portugal, Italy, Ireland, and Spain all have serious debt problems. You’ve seen the headlines. Yet, as soon as the governments tried to implement some austerity, there were public demonstrations and riots. Those governments aren’t going too far down that road. So far, it looks like there isn’t a lot of enthusiasm in the U.S. for lower spending and higher taxes. We’ll learn more in the next year.
The European peripheral countries now are looking for a combination of debt restructurings plus bailouts from the established European countries. The details of that combination are what the governments have been negotiating since last year. They had a summit March 24 and 25 at which they agreed to push the negotiations into June.
The peripherals European countries can’t inflate away their debts, because they don’t control monetary policy. In fact, the European Central Bank is taking the opposite tack. Yesterday it tightened monetary policy with a small increase in interest rates. It’s been slowing tightening policy over the last year.
The U.S. so far is pursuing a strategy of effectively defaulting by using an inflationary monetary policy to cheapen its currency. The Federal Reserve’s been left to fight the financial crisis alone. It’s determined it rather would depreciate the currency and support the economy than allow the private sector deleveraging progress alone. Some Fed members are starting to complain about this policy and argue the Fed needs to pull back from its quantitative easing programs and raise short-term interest rates. Rising prices for gold, silver, and other commodities indicate the markets don’t believe yet that the Fed is likely to go in that direction any time soon.
I have views of what can and should be done, but they don’t affect the investment recommendations. We respond to actions that are being taken, not what we’d like to happen or even expect to happen. Our portfolios continue to do well in this uncertain environment. We own stock funds, a hedged stock fund, high yield bonds, preferred securities, and mortgage securities. In the Retirement Paycheck portfolio we also own some gold and gold-related stocks. We’re earning safe, high yields without the interest rate risks of treasury and corporate bonds. The Invest with the Winners portfolio is on fire, because it’s owned iShares Silver Trust for several months.
