November 2011

December 1, 2011 11:15 a.m.
Responding to the Central Bankers’ Big Move

Central bankers made a big splash Nov. 30 with coordinated announcements to make dollar loans available to European banks at lower interest rates. Global markets in risky assets responded with large gains. Here’s my take.

There’s been a quiet run on European banks for a while now. They need short-term loans to finance their regular activities and haven’t been able to roll over their existing loans. They’ve been shut out of U.S. money market funds since U.S. investors became concerned about the state of European banks. Other private investors also have realized that it’s foolish to lend money to banks with so many bad loans on their books.

The central banks saw signs that global capital markets were nearing the type of freeze that occurred after Lehman Brothers filed for bankruptcy in 2008. They might even have been worried that one or more banks were on the edge of failing. So they saw a real problem either existing or on the horizon and took pre-exemptive action. The Fed initiated a program in September to encourage European banks to borrow dollars from it, but it wasn’t used much. Perhaps the interest rate charged was too high, so lower rates were a part of the new program.

Two recent events triggered the action. Last week Germany floated a bond offering and had very weak demand. Then, on Tuesday Nov. 29 Standard & Poor’s downgraded the credit ratings of a large number of global banks.

Risk asset markets usually respond to such actions with a sharp upward move, and this one was no different. The initial move is a short covering rally. Investors who have negative positions on risky assets realize the new program is likely to attract investors to the markets, and they reverse their negative positions as soon as possible. That makes the initial rally even stronger than it would have been.

After a time-hours, days, or weeks-investors take a longer-term perspective. They review whether the action solved a problem or merely was a bandage.

In this case, the central bank actions didn’t solve or even address any underlying economic problem or help the real economy. The actions were to solve a liquidity problem for banks. The underlying problem is insolvency of governments in Europe and the banks who made loans to them. Nothing new was done to address that.

The most optimistic case is that later in a little over a week the European finance ministers will meet to discuss the debt crisis again and that this action was part of a coordinated plan to have a real solution. There’s nothing public to indicate that is the case, but it’s possible. Many European are hoping the European Central Bank will announce that it will buy all of the debt and bonds European banks want to sell to them, or at least buy more than it is buying now. I don’t think that’s likely.

Europe has to undergo a significant deleveraging, because governments and banks have too much debt. There’s no easy solution to it.

In short, I don’t see the central bank actions as something that triggers an investable rally. It was good for short-term traders but doesn’t change much for an investor who takes a longer-term view than a week or so. The benefit of the moves is that a seizing up of the financial system was avoided, but the debt overhang still exists.

November 26, 2011 09:00 a.m.
Your Retirement Finance Week in Review

Market action in the past week continued to be all about Europe. The crisis in Europe clearly is spreading. Interest rates are spiking on bonds issued by both Italy and Spain. France also suffered a hit in the market during the last couple of weeks and hasn’t recovered from that. Germany made a bond offering and received only 35% of the buying interest it expected.

There’s a growing recognition of several points investors resisted for more than a year. The crisis clearly now is about more than Greece. Also, the austerity measures (higher taxes and lower government spending) being imposed on the debtor countries is a bad move. The only way a government can pay off a decent portion of its debt is through economic growth that results in higher tax revenues. Austerity reduces economic growth. That reduces tax revenues and makes the government unable to pay more debt than before. The result is a death spiral.

Another point gaining acceptance is the amount of debt involved is much higher than recognized and higher than the funds set aside to help resolve the crisis. The European governments won’t be able to leverage the existing funds, because investors aren’t willing to lend the money needed to do that. Investors also aren’t willing to buy stock or bonds from banks to help rebuild their capital in the face of increased loss write offs.

The more the core European governments (Germany and France) delay serious substantive actions to resolve the crisis, the worse it will become.
In the U.S., the data continue to indicate the housing crisis is scraping along the bottom, but it’s likely to remain on the bottom for a while. The economy is growing in the 0% to 2% range, but the growth is precarious. Emerging economies are slowing, so the exports to those countries that have been a big part of profits and growth the last two years are at risk. The European crisis also threatens exports from the U.S. to Europe.

There are some indications that the European financial crisis is disrupting markets. Mohammed El-Erian of PIMCO wrote a piece for the Financial Times listing the market disruptions.

Once again, no much matters to investors until the European problems are resolved. Until then, investors need to be defensive and take only selective aggressive actions.

The Data
The data dump on Wednesday before the Thanksgiving holiday painted a mixed picture of the economy and provided something for both bulls and bears.

But the first report of the week was existing home sales. This excited some analysts because it showed a 1.3% increase in sales over the month and 13.5% increase year to year. These numbers exceeded forecasts. Another positive note was that the inventory of homes for sale fell, indicating supply and demand are getting back in balance. The less optimistic analysts emphasized a few other points. The data are prepared and presented by the National Association of Realtors, which some believe painted undeservedly optimistic pictures of their data during the boom and continue to do so. Inside the data is a note that cancellations of purchases spiked to 33% for the month, up from 18% in September (which is still high). Cancellations have been high because buyers who sign contracts either can’t get financing or receive low appraisals.
On Tuesday, the second GDP estimate for the third quarter was scaled down to 2.0% from 2.5%. The culprit in the revision was business inventory, and it’s likely this will be revised down again in the third and final estimate next month. Other elements of the estimate also were revised down with only exports revised upward. As I’ve been saying for a while, the economy is growing at 0% to 2%, and those who latched on to the initial GDP estimate of 2.5% last month were making a mistake.

The durable goods orders were down, but less than the consensus and slightly less than the previous month. There’s not much new in this report. Manufacturing has been the strongest part of the economy since the bottom in 2009. Surveys of households and businesses indicate, however, that durable goods purchases from both are likely to decline in coming months.

Personal income and spending provided another puzzle for analysts. Income rose a healthy amount for the first month in a while, 0.4%. The year-to-year increase was 3.9%. In past months consumer spending had increased more than income, indicating consumers were reducing savings to maintain living standards. But in October spending rose only 0.1%, well below estimates and previous months. It could be that the drop in gasoline prices accounted for much of the drop in spending. It also could be that consumers finally are allowing their spending to fall to match their incomes. But the rise in incomes could mean that, while unemployment remains high, those that are employed are able to earn more.

Inflation as measured by the personal consumption expenditures index declined from the prior month. It measures 1.7% year to year for core spending and 4.7% year to year for all spending (down from 5.3% the previous month).
Initial jobless claims stayed roughly around the 400,000 monthly level but reversed the steady decline of recent months, rising to 393,000. It is the third week below 400,000. Again, this shows no deterioration in the economy or employment picture, but it also doesn’t give much hope for a decline in the unemployment rate or a boost in economic growth above the 0% to 2% range.
Consumer Sentiment, as measured by the Reuters/ University of Michigan index, fell only 0.1 to 64.2. The current conditions component of the index rose only one point. The expectations component fell nearly one point. Expectations in these surveys generally is a good forecaster of consumer spending a few months down the road.

The Markets
Most markets continued their path toward the October lows. U.S. stock indexes declined 7.6% over the last two weeks and are down 3% for the year. The Dow declined 4.8% last week, its worst Thanksgiving week since the exchanges started observing the holiday in 1942. The NASDAQ has done worse, declining 11% in four straight weeks of losses.

European stock markets also have been declining, though they did rise on Friday. That produced this choice quote from Barron’s Online: “Investors found some solace after a meeting of leaders from the euro zone’s three largest economies failed to produce any additional negative news.”

Emerging economy stocks have been doing worse than U.S. and European equities. That’s partly because emerging economy stocks are more volatile than developed country equities and partly because the emerging economies are hurt by the crisis. They can’t export to Europe if growth is falling. They also can’t obtain financing from their usual European banking sources when those banks must increase capital ratios to offset losses on European government debt.

Treasury bonds had a good week. Yields fell to their lowest levels in two months until some profit taking pushed yields a little higher Friday. The rise in treasuries is a combination of investors seeking a safe haven during the crisis period and a response to slower economic growth in the U.S.
The dollar had a good week, also serving as a safe haven.

Gold has been declining for 10 days. It’s at its lowest point in over a month and is nearing the lows hit in mid-October. While gold normally would serve as a safe haven in a crisis, it appears that leveraged investors are selling gold to cover margin calls on other investments. It’s also likely that the momentum investors who purchased gold during the summer and early fall are bailing out now that it’s no longer rising steadily.

Vanguard Long-Term U.S. Treasury Bond fund and Tocqueville Gold are not near their sell signals. But Tocqueville Gold could hit the sell signal if we have another week like the last one.

Some Reading for You
There are only two successful investment strategies: value and momentum. You can read the data and academic arguments to support that statement here.
What’s holding back economic growth. You can find a presentation by some prominent economists and slides to support their views (which generally agree with mine) here.

Last week Barron’s had a cover article on high yield investing. It doesn’t cover much new ground, but it’s worth a read if you have a subscription.
I comment on these items ad more on my public at http://www.bobcarlson.net.

November 14, 2011 09:00 a.m.
Your Retirement Finance Week in Review

Thank you, to all of you who sent your thoughts on the format of these e-mails. The strong consensus of those who responded is that you like this format and information. So, we’ll keep it going forward, with perhaps a few modifications that some suggested. Again, thank you for your time and encouragement.

The markets continue to be dominated by news events rather than economic and market fundamentals. The European sovereign debt crisis was the major newsmaker last week. But much of the concern shifted from Greece to Italy as the debt problem spreads. Markets declined when investors were concerned about Italy, and soared when it appeared there was a new solution to its debt problem.

This week and next be prepared for another news source to affect markets. The so-called Super Committee in Washington that is working on a deal to reduce U.S. government spending and the budget deficit has a Nov. 23 deadline to reach a consensus and issue a report. I don’t have a clue what, if any, agreement they’ll reach, but markets will rise and fall as rumors of deals and failed deals are reported. It’s another reason to expect the high volatility of the markets to continue.

Overall, the data continue to indicate slow economic growth in the U.S. that is likely to slow going forward as both household spending and business investment decline a notch or two. Europe could be in a recession at this point. Emerging economies continue to grow but at a lower rate than early in the year. I expect markets to continue largely in the trading ranges they’ve been in for 2011. That’s why it’s best right now to focus on safe income while grabbing a few opportunities in the markets when they appear.

The Data

There wasn’t a lot of data released last week. Consumer credit expanded a bit in September, but it was a modest increase. In addition, the increase was concentrated in student loans and auto loans. Credit card debt didn’t change much. There was an increase in mortgage applications for both refinancing and purchases, thanks to continuing declines in mortgage rates. This is the third increase in a row, but overall mortgage applications still are well below average levels. In other words, the U.S. economy continues to deleverage.

Weekly unemployment claims came in at 390,000. That dropped claims below their recent level around 400,000 and also brought the four-week average to its lowest level since April. We’re still a long way from an employment market that will bring down the unemployment rate and bring total jobs held near the 2007 peak, but it’s a sign of potentially a slow, steady improvement in the jobs picture. We’ll see if it holds.

The University of Michigan Consumer Sentiment index rose a bit, for the third month in a row. The overall reading still is well below average and only a bit above the worst levels of the financial crisis. The sentiment reading also isn’t consistent with recent increases in household spending. Typically, low consumer confidence and sentiment readings indicate lower spending in coming months. We’ll see if that holds true. Some analysts believe the consumer confidence and sentiment surveys are unduly influenced by negative headlines, and that households are in better financial shape than survey respondents admit.

The Markets

It was another wild, volatile week in equity markets. They dropped sharply on Tuesday and Wednesday on bond news from Europe, especially a spike in Italian bond yields. Then, they recovered the rest of the week to end with a slight gain for the week as investors were relieved by political changes in Europe. Emerging market stocks essentially followed this pattern, but they didn’t fully recover by the end of the week, falling about 2% for the week.

Treasury bonds moved in the opposite directions of stocks, though with not as much volatility. Long-term treasuries ended the week with a loss of less than 1%. Gold also had an up and down week. Though it’s supported to be a crisis hedge, gold tracked stock markets closely last week. It ended the week with a slight gain. The dollar also went up and down during the week but ended the week roughly were it began.

In other words, someone who didn’t check his portfolio until the end of the week would have thought it was a boring week with only slight changes. In fact, it was a very volatile week with markets moving sharply in both directions. I believe you should expect more of this for at least the next few weeks because of the European debt crisis and the deadline for the Super Committee in Washington.

Some Reading for You

There’s a nice profile of Daniel Kahneman in Vanity Fair by Michael Lewis. Kahneman is the psychologist who won the Nobel for Economics in 2002 for his research showing how people are hard wired to make certain types of financial mistakes.

There are a lot of questions about what the Super Committee might report, if anything, on Nov. 23. Read this analysis and projection by Fred Barnes of The Weekly Standard and you’ll be better informed than most.

Long-term care costs continue to rise, but at a lower rate. Read a summary of the MetLife survey here.

You can read more interesting items on my public at http://www.bobcarlson.net.

November 8, 2011 04:15 p.m.
Your Retirement Finance Week in Review

Please take a few minutes to help me this week. For a while now I’ve been writing these Journal entries in the “Your Retirement Finance Week in Review” format. I’d like to know what you think about it. Is this useful to you and does it fill a need? Or would you like me to address other topics instead of or in addition to what I’ve been filling these entries with. If you have any thoughts, please send them to me at BCarlson@RetirementWatch.com. Thank you.

Last week the economic data was mixed. The markets also were mixed, with the ups and downs dictated primarily by the news coming out of Europe. The sovereign debt deal was on-again and off-again each day, sometimes several times in a day.

Here’s my rundown of the week.

The Data

The key economic report for the week was the nonfarm payroll report on Friday, which was supplemented by several other employment reports during the week. New jobs came in less than expected, but the August and September jobs created were revised upward by over 50,000 jobs for each month. Even so, the number of new jobs created isn’t enough to bring the unemployment rate down by much or to restore total employment to its previous peak. Private sector jobs increased, while losses of government jobs reduced total jobs growth for the month. Average hourly earnings rose as much as expected, and the average workweek remained the same as last month.

The unemployment rate dropped from 9.1% to 9.0%, because it is computed from a separate survey of households, and they reported a large number of people being newly hired. We’ll have to see if that turns out to be more accurate than the other data.

The NFP was consistent with most of the other jobs data released for the week. New jobless claims were a little better than expected at 397,000, but still in the range they’ve been in for months. The ADP report reported 110,000 private sector jobs created, which was consistent with expectations and with the NFP report. The Challenger job cut report showed a declined from a high number in September and is roughly at the level the report has been in since early 2010.

The bottom line continues to be a stable employment situation that shows slow corporate hiring that isn’t likely to reduce the unemployment rate much.

Other data also was mixed. Chain store sales revealed that some stores are doing well while others aren’t. As a general rule it appears that high-end and low-end retailers are doing well, while those in the middle are struggling or mixed.

The Institute of Supply Management survey (formerly the Purchasing Managers’ Survey) came in below expectations and below last month’s level. The level came in just above recession levels, but a positive signal was a rise in new orders, a change from last month. The Chicago Purchasing Managers’ Index, on the other hand, showed good growth in manufacturing in the Midwest. This report is much better than other reports, so it’s tough to draw conclusions from it.

In Europe, the European Central Bank reduced interest rates. It indicated the continent probably is in a recession at this point, and the ECB is trying to keep it short and shallow.

Overall the data indicate that businesses continue to invest in their businesses through equipment purchases but not by hiring employees. It’s hard to see how household demand will rise under these circumstances. Manufacturing also might not remain as strong as growth slows in Europe and the emerging economies.

One piece of data that isn’t widely reported, because it’s proprietary, is the Weekly Leading Indicator of the Economic Cycle Research Institute. This indicator has been pointing to a recession for several weeks now.

The Markets

The investment markets also were mixed, reflecting both the economic data and the chaos in Europe. U.S. stocks were down for the week, their first weekly decline in in the past six. A sharp drop in the last hours of Monday’s trading was followed by modest increases on Wednesday and Thursday and a decline on Friday. The decline for the week was about 1%. Financial stocks did the worst, falling 5.4% for the week. I suspect October’s rally was stronger than the economic and earnings data justify.

Treasury bonds took the opposite path. Long-term treasuries had a strong gain late Monday. They followed with modest declines Tuesday through Thursday, and a small rise on Friday. The net for the week was about a 2.5% gain. Corporate bonds and high-yield bonds also have been recovering the last few weeks.

Gold also did well, rising about 2% for the week. Our addition of Tocqueville Gold to the portfolios recently has delivered about a 15% return since the recommendation was posted on the web site.

The dollar declined for the week.

Some Reading for You

The failure of MF Global was big news this week. There’s a good review of what went wrong on Bloomberg.com. It’s a story about lessons that weren’t learned.

The problem with the European debt crisis, much like the bankruptcy of Lehman Brothers, is the hidden risks. Here’s a good explanation of what you need to be concerned about.