Economic Notes – December 17, 2012

December
17

Written by: Jon McGraw

Note: In an effort to provide an even clearer at-a-glance view of the weekly results, we’ve added some symbols to help interpretations of the previous week’s information.

Notes key: (+) positive/encouraging development, (0) neutral/inconclusive/no net effect, (-) negative/discouraging development. We’re always open to feedback, as we attempt to keep these reviews as informative as possible.

(0) The FOMC meeting occurred last week, and, per the note we sent out last Wednesday, the Fed decided on a continuation of their current accommodation stance, but also a shift regarding communications surrounding their assessment of thresholds used. The ‘calendar-based’ forward guidance used lately has been replaced by ‘outcome-based’ guidance. The ‘outcomes’ needed to re-evaluate the present path (and remove easing) would include: (1) an unemployment rate below 6.5%, (2) 1-2 year forward-looking inflation of no higher than 2.5%, and (3) ‘well-anchored’ long-term inflation expectations (interpreted as not too high, but some room for flexibility included).

From a timing standpoint, the expected result is not largely different (based on current forecasts) than the mid-2015 calendar-target period, but this change does clarify a few of the underlying data points the Fed deems most important. Additionally, it appears the Fed will be continuing asset purchases of Treasuries and MBS beyond the expiration of ‘Operation Twist’ at the end of this year. This action was largely expected, although the ‘outcome-based’ guidance was a bit of a surprise to markets—despite the fact that economists have discussed the potential of a communication update for months. For now, the foot is solidly on the gas pedal—if for nothing else, to keep us at a consistent, steady speed rather than drifting into idle or, worse, should we encounter a few hills on the road.

(0) Retail sales were up +0.3%, which disappointed analysts expecting more like +0.5%. Removing autos from the figure resulted in a flat reading, which was on target with estimated due to an offsetting drop in gasoline sales and rise in building materials activity. Parsing this out further, the ‘core/control’ sales number (which removes volatile results in autos, gasoline and building materials sales) gets us to a gain of +0.5%, which was better than forecast by about two-tenths of a percent. That is the real story of the report—although we have to dig a little deeper to find it. Within that group, online sales and electronics posted gains—not surprising, due to the season we’re in the midst of. Online sales are taking an increasing share of overall retail sales, relative to the conventional ‘brick-and-mortar’ stores.

(+) Industrial production in November was stronger than expected, gaining +1.1% versus consensus estimates of +0.3%. According to the Fed, much of this rebound was as a result of Hurricane Sandy, as levels are now back up to where they were pre-storm. All categories were higher, but were led by stronger increases in motor vehicle and parts production. (+) Capacity utilization for November came in at 78.4%, which was a bit above the expected 78.0% level and in line with the improved industrial production numbers.

(0) The U.S. trade deficit (officially, the ‘trade balance’ of exports less imports, but chronically in deficit, so we generally refer to it as that) widened for October, to -$42.2 billion, which was a bit less than the -$42.7 expected. It seems the hurricane played a major role here, especially as the New York harbor area is responsible for some 10% or more of U.S. import/export activity, namely to Europe. European activity was down anyway (almost -9% year-over-year) due to slow economic conditions there, hurricane aside.

(0) Wholesale inventories rose more than anticipated in October, at 0.6% for the month versus 0.4% forecast. When the sporadic results from the petroleum group were excluded, inventories rose by 0.8%. Business inventories rose a similar 0.4%, right on target with forecasted levels.

(+) Import prices for the month of November fell -0.9%, more than the expected -0.5%—largely the result of lower prices for crude oil. As our largest import (20% of the annual total), oil price changes can affect these numbers dramatically from month-to-month. Consumer goods prices also fell a bit, but more moderately. What this shows is that inflationary pressures from the goods input side remains tempered, which is a positive.

(+) November’s consumer price index (CPI) results came in a bit below expectations, -0.3% month-over-month—just a shade lower than the forecasted -0.2%. A -4% fall in energy prices (notably gasoline) largely accounted for the decline. The year-over-year figure tempered to +1.8%, which is well below the Fed’s target and long-term average levels of the past several decades. Core CPI, which excludes food and energy prices, rose +0.1%, which was a tick lower than the expected +0.2% rise. Year-over-year core CPI fell to +1.9%, right in line with the headline figure. Overall, inflation pressures have remained low.

(+) The producer price index (PPI) for November fell -0.8%, which was larger than the forecasted -0.5% drop, due to overall lower gas and energy prices (in keeping with the CPI results). Core PPI, which excludes energy and food, gained +0.1%, which was on target with expected and resulted in a year-over-year number of a quite moderate +2.2% increase.

(-) The NFIB small business optimism index experienced one of its largest declines ever in November, from 93.1 to 87.5, which ran counter to an expected smaller drop to 92.5. This originated from a much lower survey score for firms expecting the economy to get better (in fact, that was the lowest level of optimism in 30 years and, amazingly, much worse than during the month Lehman Brothers blew up). Unsurprisingly, this also correlated to the election results, anticipated policies of the administration going forward and regulatory uncertainty—these have worried small business owners for several years now and may have an indirect (or direct) effect on lower levels of hiring in smaller firms. Sentiment is poor, which we consider bullish longer-term, since problems have a tendency to be corrected (regress to the mean, you might say), while over-exuberance is hard to counter, without a crash of some sort. We’ll take the former.

(+) On the employment side, initial jobless claims for the Dec. 8 ending week fell to 343k, which was much lower than the expected 369k figure. Continuing claims for the Dec. 1 week were also lower, but less dramatically so, at 3,198k versus a consensus of 3,210k. These figures were much less distorted by Hurricane Sandy, so could have more ‘legitimacy’ than those in the weeks right after the storm.

Market Notes

U.S. Treasury Yields

3 Mo.

2 Yr.

5 Yr.

10 Yr.

30 Yr.

12/31/2011

0.02

0.25

0.83

1.89

2.89

12/7/2012

0.09

0.25

0.63

1.64

2.81

12/14/2012

0.04

0.24

0.70

1.72

2.87

 

Large-cap stocks were down on the week, but not by much. The Fed announcement of additional/ongoing stimulus helped mid-week, but fiscal cliff concerns seemed to temper the excitement somewhat. Smaller cap names fared a little better than large cap. In the S&P, the materials and telecom sectors outperformed, while consumer discretionary and utilities stocks underperformed on the week. The current S&P level is hovering right around its 50-day moving average, which may not matter much to the fundamental analysts, but technicians find it interesting from a momentum perspective. Both the current levels and 50-day are above the 200-day, however, which is seen as more ‘bullish’ from an intermediate-term perspective by chartists.

Anecdotally, the U.S. Treasury completed the last of its asset sales of AIG common stock—234,000,000 shares—which adds to the $15.1 billion in profit already made, no less. While that firm seemed to embody much of the financially cavalier atmosphere that led up to the 2008 financial crisis, the taxpayer bailout profit is somewhat ironic, if small, in the whole scheme of things.

Foreign stocks were the big winners on the week, with strong results in the European periphery (Greece, Spain and Italy) as well as European core and the BRIC nations. While almost all of the non-U.S. developed market group outperformed U.S. stocks, India and Japan lagged. Japan is progressing through another leadership change, which has resulted in some volatility in the Nikkei—the new leader is calling for additional stimulus to get the economy moving. Unfortunately, there are other debt-related and demographic challenges that may continue to be a difficult headwind for Japan longer-term.

Bonds lost ground overall last week, as rates rose in the intermediate- to longer-term portions of the yield curve. International bonds had the best returns, due to some weakness in the dollar and strength in Europe. Areas like high yield and floating rate eked out a flat to small positive return. We certainly hope you enjoyed our lengthy discussion last week in the advisor meeting surrounding our U.S. fixed income positioning. Bonds are sometimes considered to be a bit ‘dry’ by some, but there is a lot of thought going on behind the scenes in this portion of our portfolios.

In keeping with broader equity indexes, European REITs produced the biggest gains, followed by U.S. industrial. Other sectors lost ground, with developed Asia and U.S. mortgage and retail faring the worst.

In commodities, the small and often-overlooked livestock group (live cattle and lean hogs) ended up with the best returns on the week—up just over 2%, a shade above industrial metals. The energy group also gained a percent. Precious metals and agriculture ended with negative results, although the precious metals sub-index has experienced the best year-to-date return so far in 2012, followed closely by agriculture. Energy is solidly in last place with a -5% decline, but, as we often discuss, this sub-index is often fraught with contradictions. In this case, slightly weaker crude oil, soundly more expensive gasoline and ‘unique’ results in natural gas (spot price higher, futures and futures-based vehicles lower).

From an asset allocation standpoint, this year continues to look like a record year for inflows into fixed income assets, according to a recent Morningstar article. This doesn’t entirely surprise us, as retail investors when looked at as a single unit, tend to make behaviorally poor investment decisions. In this case, nearly $200 billion has made its way into actively managed taxable bond mutual funds in 2012—more than in 2011 and close to the 2009 level remarkably. If passive vehicles like index funds and ETF’s are included, 2012 may surpass 2009. Most of the inflows are into broader-mandate intermediate-term bond funds, with munis also receiving their share of cash, likely due to tax concerns surrounding the fiscal cliff. As we’ve learned over the years, however, extreme movements toward one asset class can be a contrary and opportunistic signal for another (such as equities, which have seen a marked absence of flows for several years and look attractive from a valuation standpoint).

Have a good week!