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Capital Markets 

2010 — A new year, a new decade, and a clean slate? Well, at least two of these are true. Time is inevitably a constant which presses on year after year. We are unable to stop it or reverse it in order to alter the course of events along the way. Given the fashion in which the previous decade closed, the onset of this new decade brings with it anything but feelings of a “clean slate.” Although we were able to dodge the “D” word last year, the economy remains on uncertain ground. We enter a new decade hoping to experience one that is characterized by stable economic growth and price stability. However, we will not be without baggage on this journey. Several mementos we have brought with us from the previous decade are known to not be conducive to growth. These include historically high debt levels coupled with massive budget deficits, high unemployment, a deleveraging consumer, an expansion of government regulation, and an unusually high degree of political uncertainty.

Many of these nagging souvenirs from the past have been building over the course of the last decade or longer, while others have just recently developed and will undoubtedly grow well into this decade. The result will be a journey wrought with impediments to the desired Goldilocks path of “not too hot and not too cold.” The dynamic we face this decade is truly unlike many from the past. Policy leaders and central banks, which until recently have been focused on averting a greater crisis, are now accountable for paving the path to recovery. Striking the right balance between delicately tightening monetary policy, controlling unruly budget deficits, and maintaining price stability will prove to be a difficult task. More so, while these efforts will be taking place on a global scale, autonomous paths have and will continue to develop. Divergences of policy actions may also result in further impediments along the way, as the appropriate recovery path for one country may have unintended consequences for another.

Gratuitously Unnecessary Perspective of the Month February 14 Has Gone to the Dogs According to the 2010 National Retail Federation Consumer Intentions and Actions Survey, the average American plans to spend $103 on Valentine’s Day gifts. This year, a total of $14.1 billion is expected to be spent on Valentine’s-related items for significant others, children, friends, teachers, co-workers – even pets! Think we’re kidding? A quick Google search will reveal everything from heart-shaped bones to bone-shaped boxes of “dogolates.” Canines around the world are rejoicing that “heartworms” are not anywhere on the list of items for sale. Source: http://nrmarketwatch.com/

Throughout January, the weight of the baggage that we carry was not ignored. Even the encouraging news of stronger-than-anticipated GDP growth, an improving manufacturing sector, and moderately better-than-expected reported earnings were not enough to yield a continuation of positive results for risk assets. A familiar maxim suggests, “As goes January, so goes the year.” Like any adage, the foundation originates from a historical trend or anomaly, but as another common saying suggests, “There are exceptions to every rule.”  


Source: PMFA 

Mounting uncertainty often has a direct impact on market volatility, and there was no shortage of either in January. Uncertainty and concern surrounded China’s policy tightening, Greece’s potential insolvency, proposals related to new regulation of U.S. banks, and even Fed Chairman Ben Bernanke’s confirmation to a second term. As market participants continue to seek clarity among the mountain of uncertainty, we expect volatility to remain heightened for the foreseeable future.


Source: PMFA, Yahoo Finance 



Source: PMFA 

If the global economy continues its path to recovery, we expect upward pressure on global interest rates to lead to an increasingly difficult environment for fixed income investors. Credit spreads have narrowed significantly, resulting in less cushion to protect investors against rising interest rates. Meanwhile, diverging policy responses, specifically between developed and emerging countries, may lead to opportunities in economies with higher growth expectations. In light of these expectations, greater flexibility in fixed income strategy should allow investors to benefit from developing opportunities.


Source: PMFA 

Overall, fixed income indices were positive for the month, as Treasury yields fell. Meanwhile, many alternatives followed a downward path similar to equities. After a positive return year in 2009, REITs began 2010 with a loss of nearly 6.0%. We continue to remain cautious of REITs given current valuations and the likely potential for further write downs within the corporate real estate sector. Falling commodity prices across various subsectors cumulatively contributed to a broad loss in commodities of over 7.0%. Uncertainty over the sustainability of the global recovery and a strengthening Dollar over the course of the month all contributed to retreating prices. 

Economy

GDP

The first look at GDP growth reflected an above-expectation result of 5.7% for the fourth quarter of 2009. This follows the 2.2% advance in the third quarter. The primary contributor to growth was a sizeable increase in private inventories as well as improvement in net exports. Consumer spending was positive, although the pace of spending growth was slower than in the previous quarter.


Source: PMFA, Bureau of Economic Analysis (BEA)

As the largest component of GDP, personal consumption often becomes a strong contributor to growth following recessions. This time, consumers are less likely to lead the recovery. Consumer sentiment remains low by historical standards as the list of obstacles facing consumers has grown. Income growth has been subdued, personal balance sheets are depressed, credit availability and demand remain tight, and the labor market is persistently weak.


Source: PMFA, BEA, Conference Board 

Inflation 

Both headline and core inflation indicators were mixed during December, as the CPI fell by 0.2%, and the PCE rose by 0.1%. On a year-over-year basis, the change in core inflation remains within the Fed’s implied range. Headline indicators, which are traditionally more volatile, troughed in July and have since been on an upward trend. With significant declines from the fourth quarter of 2008 no longer part of the equation, we expect even headline numbers to moderate further.


Source: PMFA, BEA, Bureau of Labor Statistics (BLS)

Near term, we continue to expect that inflation will remain contained. Although massive stimulus has been injected into the system, the velocity of money has been muted by both weak credit demand and more limited availability. Additionally, capacity utilization remains low and wage-driven price pressures in an environment of high unemployment are not a concern. Over time, as the slack in the economy is absorbed, we expect that rising inflation may be a more pressing concern. With only a handful of effective options for the government to reduce debt levels, paying it off with a dollar devalued by inflation becomes a potential concern down the road.


Source: PMFA, BEA, BLS

Interest Rates

Although interest rates shifted downward over the course of the month, the yield curve remains steep. In mid-January, the difference between the 10-year yield and the two-year yield, one measure of steepness, reached its widest point ever at 2.9%. Short-term yields remained at virtually zero during the month, while yields for longer duration Treasuries receded some over the month. The 10-year Treasury ended January at 3.6%, a 22-basis point decline since the end of December.


Source: PMFA, U.S. Treasury 

The Federal Open Market Committee met in late January and maintained the fed funds rate at the exceptionally low range of 0% – 0.25%. While they continue to acknowledge that economic activity has strengthened, they refrained from the shift to more hawkish rhetoric, reiterating in their January 27 statement that economic conditions “are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

Employment 

Mixed results regarding the employment situation were released in January. A surprise drop in the unemployment rate to 9.7% was encouraging as this rate reached a five-month low; however, a separate survey of employers reported continued job losses of 20,000 in January. Instead of adding jobs for the month, employers looked to further utilize existing employees, which boosted the average hours worked for the month. A restatement of historical payroll data showed that more than 8.4 million jobs have been lost since the recession began. This will be a significant hurdle to overcome, one which will take years to reverse before the economy once again reaches full employment.


Source: PMFA, BLS



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Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.