They don’t ring a bell

According to hoary Wall Street lore, they don’t ring a bell when a bull market ends or a bear market begins. (Those would actually be the same thing). But Federal Reserve Chair Janet Yellen did all but that today when she spoke at the Kansas City Fed’s economic conference in Jackson Hole, Wyoming.

“I believe the case for an increase in the federal funds rate has strengthened in recent months,” Yellen said, which is just about as close to skywriting “RATES ARE GOING UP!” as a Fed chair can get. Wall Street, which has anticipating higher rates since 2009, reacted predictably, selling off stocks and bonds at the same time. The Dow Jones industrial average fell 53.01 points, to 18,395.40, and the bellwether 10-year Treasury note yield rose to 1.635%. Bond prices fall when interest rates rise, and vice-versa.

Naturally, the case for raising interest rates soon is debatable. In terms of timing, the Fed is traditionally reluctant to raise rates in the months before a presidential election. If that reasoning still holds, the next opportunity to increase the key fed funds rate would be in December.

And on a relative basis, interest rates are pretty high already. The fed funds rate is 0.25% to 0.50%. The European Central Bank’s rate is zero, as is the Bank of Japan’s. The Swedish central bank’s rate is -0.25%, and the Swiss government rate is -0.75%.

The Fed doesn’t control long-term interest rates, but the picture there is just as grim. Germany’s 10-year yield is -0.07%. France’s decade note yields 0.17%, albeit with a certain je ne sais quois. Italy’s 10-year rate — Italy’s! — is 1.17%.

What is starting to make the Fed uneasy, however, is rising wages. The Fed has been able to flood the world with easy money for nearly a decade without fear of a wage-price spiral because wages have been flat for more than a decade. You just can’t have a wage-price spiral without higher wages.

Oddly — and somehow justifiably — those at the lowest end of the wage spectrum have been seeing the biggest wage increases, thanks in large part to state-mandated minimum-wage increases. But that’s not the only reason. Many companies, such as Walmart and McDonald’s, have come to the realization that they rely heavily on those who face the public. Those people are almost invariably on the lower end of the wage spectrum.

Perhaps Lily will get a raise.
Perhaps Lily will get a raise.

Service companies are also discovering, to no one’s surprise than theirs, that people who don’t make much don’t feel a lot of loyalty to their employers. Low-wage employees will often gladly jump ship to another company that pays better wages. In the recession, companies could simply say, “Be glad you have a job.” But many of the new job gains have gone to low-income employees — so much so, in fact, that there’s a relative shortage of people willing to take low-wage jobs.

“Wage acceleration has been concentrated in low-pay sectors, such as restaurants and retailing,” says Bank of America Merrill Lynch. “In our view, the increase in low-pay wages is due to state-level minimum wage increases and a shortage of younger, less-educated workers. We see sharp increases only in low wage sectors: broader wages should rise more gradually as joblessness falls.”

The Fed raises interest rates to slow the economy and reduce the threat of inflation. But bear in mind that interest-rate increases take a long time — 18 months or so — to fully take effect on the economy. Furthermore, a more or less normal fed funds rate, which is neither accommodative nor restrictive — is somewhere between 3% and 4%. It will take many more quarter-percent rate hikes to get back to normal.

The big danger is that the economy isn’t exactly boiling over. Current estimates for third-quarter gross domestic product are a 1% increase or less.

If you’re looking for a rate shock, you probably won’t see one any time soon. You may start to see better rates on bank CDs: The top ones now yield about 1%, according to Bankrate.com. But you should start to be wary of interest-rate sensitive stocks, such as utilities and preferred stocks. And if you’re thinking of loading up on bonds, you might want to wait a bit.

 

 

 

 

The bulls are back in commodities

By and large, the only people who rejoice when the price of raw materials rise are the people who produce raw materials. And according to Bloomberg, those folks are doing a happy dance these days:

“The broad-based recovery in commodity markets this year has tipped several markets into bull market territory,” Mark Keenan, head of commodities research for Asia at Societe Generale SA in Singapore, said by e-mail. “Overall, sentiment is good but remains cautious, the market is evolving significantly, specifically across the oil markets.”

By general agreement, a bull market is a 20% rise from a low, and commodities have been engulfed in a bear market for nearly four years. The most recent low for the Bloomberg Commodity Index was January 20. It’s still down 50% from its high. So this is a nascent bull market, if it indeed is one.

Typically, rising raw materials prices means — duh — higher prices for stocks of miners. The most egregious is the jump in the price of gold mining stocks: The average equity gold fund is up 68% this year, while natural resources funds are up 10.51%. Broad-based commodities funds are up 7.62%.

It’s also an inflation warning: The price increases for things like steel, oil and zinc pass through the manufacturing chain and ultimately to the consumer. While the Federal Reserve has to be wary of the rotten jobs report Friday, it also has to be aware of the risk of inflation from rising commodity prices.

The Fed is also in a peculiar bind. The next chance to announce a rate hike is during the Democratic convention. After that, the Fed runs the risk of raising interest rates during a presidential election, which will, no doubt, have politicians crying foul. It may be that your best move might be to add a bit of inflation protection to your portfolio, either in the form of Treasury Inflation-Protected Securities (TIPS), or small doses of commodity-sensitive funds.

Other things to watch this week: Not a lot. Fed Chair Janet Yellen speaks today at 12:30, but it’s unlikely she’ll say, “Better refinance that mortgage now, if you know what I mean.” Wall Street is likely to overreact anyway. The biggest number to watch is Friday’s consumer sentiment survey from the University of Michigan, especially consumer’s outlooks for pay hikes.

And take a moment today to remember the day. June 6, 1944 was a very big day for many brave young men.

 

 

Greetings from Lacunaville

SDSC_0368tarting in January, I’ve been writing full-time for InvestmentNews, doing a monthly column for Money magazine, and studying for the Certified Financial Planner mark. (This, apparently, is also a test of your prowess with a hand-held calculator). And I went to Africa.

The blog, as you may have noticed, has, um, languished. I’m hoping to revive it on a somewhat irregular basis, which, come to think of it, is pretty much its usual schedule.

I’ll be updating my links pages in the next week or so. In the meantime, here are some things to watch for today, as well as some things I’ve found interesting or peculiar.

This week, all eyes are on the Bureau of Labor Statistics’ employment situation report, out at 8:30 a.m. Friday. But the stock market seems to be resigning itself to an interest rate hike, probably in June or July. (A later hike would give the impression of a political motivation, and the Fed generally doesn’t like to do that). The current consensus estimate for new nonfarm jobs is 158,000, according to Bloomberg, with the unemployment rate falling to 5%. (And, yes, the total unemployment rate is still high, but it’s the nonfarm payrolls number that Wall Street watches.)

Wages also seem to be firming up, and it should be interesting to see if traditional summer employers, such as ice cream vendors and lawn mowers, have a hard time finding help this year. All of these would seem to give the green light to the Fed to raise rates.

Of course, we’d be talking about a lordly fed funds rate of 0.5% to 0.75% after a Fed hike, an increase that will be promptly reflected in your credit card bill and eventually in your money market mutual fund account. For those who still watch their money fund account, the average money fund now yields 0.10%, nearly triple its rate at the start of the year.

DSC_0353The stock market typically dislikes interest-rate hikes. Higher rates mean bonds become more competitive with stocks, and increase short-term borrowing rates. On the other hand, higher short-term rates mean that companies will earn somewhat more on their cash, and that savers will earn slightly more on their cash.

The old adage about Fed rate hikes — three steps and a stumble — meant that the stock market takes the first two hikes as a sign that the economy is improving, and rallies. At the third hike, stock investors realize the Fed wants the economy to slow, and stocks sell off. Bear in mind that the adage originated when a normal fed funds rate was 4% to 5%. It would take a stairway, not a few steps, to get us back to the traditional stumble level, assuming the Fed raises rates at a quarter-point a pop.

I’m an optimist, and think that rising earnings are a good thing — in fact, the one thing that the economy desperately needs for sustained growth. Most companies, despite their complaining, have nice profit margins, good balance sheets, and plenty of cash. They might even be surprised to learn that when their employees get raises, they spend more — and even on the products their employers sell.

DSC_0488The one caveat: Stocks aren’t cheap, at least by the price-to-earnings ratio of the Standard and Poor’s 500 stock index. The current PE, based on forward earnings estimates, is 17 — a tad feverish, although nothing like the levels during the technology bubble. Nevertheless, at these levels, it’s a bit like driving a bit too fast on old tires. If the market takes a rate hike really badly, investors could find that both bond and stocks slide off the road. And in that case, having a bit of cash in a money fund might be a good safeguard.

 

The week ahead

Only two things matter in this first week of the new year: China and jobs. And China, frankly, isn’t looking too good.

The market plunged at the open Monday on news that Chinese manufacturing was far worse than Wall Street expected. The Chinese purchasing managers’ index fell to 48.2 last month, vs. 48.6 in November, it’s 10th consecutive decline. When the index is below 50, the manufacturing sector is in recession.

The Chinese stock market took one look at the numbers and promptly plunged 7% before circuit breakers kicked in. Wall Street took a sober look at the Chinese market’s reaction and promptly panicked. The Dow Jones industrial average is down 318 points, or about 1.8%, as I write this.

China takes these things seriously: So seriously that Chinese CEOs are starting to mysteriously disappear. If I were a Chinese CEO today, I’d be hastily packing my bags.

The stalling Chinese economy will weigh heavily on the U.S. market, since so many U.S. companies have been counting on China for increased sales and growth. So today, the stock market will be digesting this news, and discounting stocks across the board.

fredgraphAfter that, Wall Street will spend the rest of the week fretting about jobs. And there are all sorts of indicators to watch in the run up to Friday’s jobs report. (Which, for the record, is expected to show 200,000 new jobs in December, vs. 211,000 in November.)

  • Tuesday is motor vehicle sales, which should show fairly robust growth in what was once the nation’s largest employers. Analysts are expecting fairly robust gains in December, thanks to low gas prices and the prospects of modest raises in 2016. Another factor: The average U.S. auto is more than 11 years old. Cars age better than they used to, but there’s a lot of pent-up demand for new cars.
  • Wednesday is the ADP Employment report, which is a pretty good predictor of how the Friday jobs report will turn out. The consensus on the report, which excludes government jobs, is for 190,000 new jobs in December.
  • Thursday is the volatile weekly unemployment claims report, has ticked up to the highest levels since July, when the numbers flirted with lows unseen since the Nixon administration. Another important report is the Challenger Job Cut Report, which measures mass layoffs. Many companies choose to lay off employees just in time for the holiday season, so it should be an interesting report.

 

This darn house

Those of you who own your own homes know the guilty pleasures of real estate porn. Thanks to sites like Zillow, you can see what your house is worth, what your neighbor’s house is worth, and what the inside of the tract mansion down the street looks like. (A six-screen entertainment room? Really?)

addamsIt has been a decent year for housing, helped by an average 30-year mortgage rate of 4.17% in 2015. But mortgage rates aren’t the only factor that push up housing rates, or even, necessarily, the determining one. Home prices soared in the mid- to late 1980s, when a 30-year mortgage averaged 10.21%.

What matters more is having enough income to qualify for a mortgage. Unless you can find a true cowboy lender — and they’re rare these days — your total mortgage payment needs to be less than 31% of your gross income. Someone who earns $75,000 a year would be able to afford a total monthly mortgage payment of $1,937.50.

Other rules restrict the amount of total debt you can have when applying for a mortgage. But overall, home prices depend on affordability and demand. Baby Boomers could buy houses in the 1980s despite high interest rates because their incomes were rising and home prices were low in the early part of that decade. And they were of the age when a house made sense for raising children.

The National Association of Realtors publishes a housing affordability index, which takes into account the household income, home prices and mortgage rates. The higher the reading, the less affordable homes are for the average family. affordability

As you can see, houses aren’t terribly affordable, despite low mortgage rates. The reason: Real household income has flatlined, and home prices have soared since the start of the housing bust in 2006. Homebuilders have largely concentrated on high-end housing, causing the prices of mid- and low-priced homes to creep out of reach for many families.

With luck, real — that is to say, inflation-adjusted — incomes should improve next year. Korn Ferry Hay expected U.S. workers to get an average raise of 2.7% next year, which is entirely reasonable, given the surge in corporate profits the past five years. And homebuilders are starting to ramp up production of more modestly priced homes.

Millennials, who are a larger generation than Boomers, will be slow to enter the housing market, however. They have too much college debt, and they’re paid too little to buy the few modestly priced homes on the market. Assuming mortgage rates will remain modest, it could be a few years yet before the next housing boom.

 

 

 

 

 

 

 

 

This year’s market: Better than it looks

We all have certain rituals for the end of the year. Some of us make contributions to charity. Others take down the Christmas decorations. Yet others light bonfires and bathe in the blood of an oak tree. It’s all a way to mark the end of yet another rotation around the sun, and celebrate a new one.

janus
Janus, the two-headed god of beginnings and endings.

Those of us who write about personal finance like to look back on the year’s market performance, which, unlike detonating fireworks over the neighbors’ roofs, is legal in all 50 states. And the basic takeaway this year was that it could have been worse. As of yesterday, the Standard and Poor’s 500 stock index was up 3.08%, assuming reinvested dividends.

Boring, yes? Yes. But still a better return than the average money market fund — 0.02% — and intermediate-term corporate bonds, which returned 1.08%.

The top-performing funds had two things in common. First, they avoided energy, which fell more than 20% for the year. Of the 10 top-performing diversified U.S. stock funds in the Morningstar database, not one had any exposure to energy.

The other: At least some exposure to the MAGS — Microsoft, Amazon, Google and Salesforce. Polen Growth Institutional (POLIX), the current top-performing diversified fund with a 16.8% gain this year, has about 8% of its assets in Google. Brown Sustainable Growth (BAFWX), up 15%, has Amazon as its largest holding. Prudential Jennison Select Growth, up 14.5%, has Amazon, Google and Salesforce.

All of which will tell you nothing about what will work in 2016, a year with an unusual number of variables: A presidential election with no incumbent, the first year of rising interest rates since your bond manager graduated college, and some of the lowest commodity prices since the Taft administration. It should be an interesting year.

 

 

The week ahead

“You’ll want all day tomorrow, I suppose?” said Scrooge.
“If quite convenient, Sir.”
“It’s not convenient,” said Scrooge, “and it’s not fair. If I was to stop half-a-crown for it, you’d think yourself ill-used, I ‘ll be bound?”
The clerk smiled faintly.
“And yet,” said Scrooge, “you don’t think me ill-used, when I pay a day’s wages for no work.”
The clerk observed that it was only once a year.
“A poor excuse for picking a man’s pocket every twenty-fifth of December!” said Scrooge, buttoning his great-coat to the chin. “But I suppose you must have the whole day. Be here all the earlier next morning!’

christmas_carolWe have a holiday-shortened week this week, with relatively little to make Scrooge smile. Today, the only indicator of importance, the Chciago Fed National Activity index, fell to -.30 in November from 0.17 in October, indicating a slowing economy. Employment was up, meaning that Mr. Scrooge might have to give his clerk a raise, but housing and consumer spending were down.

Tuesday, we have gross domestic product, expected to dip slightly in the third estimate for the second quarter. This could indicate relatively low inflation for the rest of the year, something that will make trading commodities a bit more problematic for Scrooge.

Also Tuesday: Existing home sales for November, also expected to fall somewhat, thanks to the declining fortunes of the oil patch.

Scrooge had a very small fire, but the clerk’s fire was so very much smaller that it looked like one coal. But he couldn’t replenish it, for Scrooge kept the coal-box in his own room; and so surely as the clerk came in with the shovel, the master predicted that it would be necessary for them to part. Wherefore the clerk put on his white comforter, and tried to warm himself at the candle; in which effort, not being a man of a strong imagination, he failed.

Wednesday is the EIA petroleum inventories report, which could prompt Scrooge to switch from coal to oil. Oil prices continue to plunge, and home heating bills should be modest this year, should it ever get colder.

Also on deck Wednesday: University of Michigan consumer sentiment, which has been on the rally recently, thanks to increased hiring and low gas prices. This will not impress Scrooge.

 

“A few of us are endeavouring to raise a fund to buy the Poor some meat and drink, and means of warmth,” said the gentleman. “We choose this time, because it is a time, of all others, when Want is keenly felt, and Abundance rejoices. What shall I put you down for?”

“Nothing!” Scrooge replied.

“You wish to be anonymous?”

“I wish to be left alone,” said Scrooge. “Since you ask me what I wish, gentlemen, that is my answer. I don’t make merry myself at Christmas and I can’t afford to make idle people merry. I help to support the establishments I have mentioned: they cost enough: and those who are badly off must go there.”

“Many can’t go there; and many would rather die.”

“If they would rather die,” said Scrooge, “they had better do it, and decrease the surplus population.”

Finally, on Christmas Eve, we have jobless claims, currently at their lowest level since 1972. Expect the four-week average to remain at those levels. And, of course, be on the lookout for ghosts.