Economic Review and Market Perspective

Economic Review and Market Perspective
April 22, 2011

Strong growth in emerging markets and accommodative fiscal and monetary policy have supported the global economy since the latter stages of the Bush administration, or for the last 30 months or so. The U.S. is ever so slowly entering the third stage of a three-stage recovery. First the economy was propped up by fiscal and monetary stimulus. Next came the second stage of inventory rebuilding wherein stocks intentionally allowed to diminish during the recession have been replenished, boosting economic activity, especially manufacturing. The final stage, much hoped for and just beginning, involves significant job creation and the emergence of self-sustaining final demand.

During the Great Recession December 2007 to June 2009, the U.S. economy lost 8.8 million jobs. Many were manufacturing jobs that have moved offshore and probably will never return. So far, "only" 1.8 million jobs have been created since mid-2009. Thus, the recovery is not really jobless, but we have a very long way to go to restore a truly healthy U.S. job market and economy.

The U.S. economic recovery, while clearly slower than desired, stayed on course in the fourth quarter of 2010 as household spending and business investment in equipment and software continued to expand, according to the minutes released by the Federal Reserve in March. While this is positive news, the Fed also expressed ongoing concern about the still high unemployment rate and inflation levels that are below acceptable levels. The Fed acknowledged that higher commodity prices have had an effect on inflation but believes that the impact will be short-lived. Accordingly, the Federal Reserve announced that it will continue to execute its plan to expand its holdings of securities. In particular, the Fed said it is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.

Gross domestic product (GDP) increased at an annual rate of 3.1% in the fourth quarter of 2010, according to the third estimate released by the Bureau of Economic Analysis, a modest upward revision from the 2.8% second estimate released in February. The increase in real GDP in the fourth quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, and nonresidential fixed investment that were partly offset by negative contributions from private inventory investment and state and local government spending. Meanwhile, the Federal Reserve, through its Summary of Commentary on Current Economic Conditions ("Beige Book"), said that reports from the twelve Federal Reserve Districts indicated that overall economic activity continued to expand at a modest to moderate pace in January and early February of this year.

Regarding employment, data for the first quarter were encouraging. The Bureau of Labor reported that 36,000, 192,000, and 216,000 non-farm payroll jobs were added in January, February, and March, respectively. Gains for the quarter were widespread with new jobs in manufacturing, construction, professional and business services, health care, and transportation and warehousing; many of the long-term unemployed appeared to be leaving the unemployment rolls.

With the job market showing signs of improvement, commodity prices rising, the U.S. Dollar falling, and the Fed continuing to inject stimulus into the system, one has to wonder what it will take for inflation to pick up. In January, the Consumer Price Index (CPI) increased by 0.4% on a seasonally adjusted basis. In February and March, the CPI rose by 0.5%. However, the Core readings (ex food and energy) were substantially lower than the headline numbers and were reported at 0.2% for each of the first two months of this year and just 0.1% in March. As a result, the quarter's core inflation had risen only 1.2% from a year earlier.

While corporate earnings have been improving, the housing market has not shown the same progress. The real estate sector remained very weak during the first quarter, especially the very important new housing component. Sales of new single-family houses declined, and existing home sales languished.

Outside the U.S., overall economic growth in the fourth quarter of 2010 did not change materially from the third quarter, as austerity measures designed to improve the financial condition of various countries in the region may have influenced growth rates. According to Eurostat, the statistical office of the European Union, GDP increased by a sluggish 0.3% in the 16 countries of the Euro area. However, the region is off to a reasonably good start in 2011, as data suggested that first quarter GDP may increase by 0.8%.

In contrast to European regions, Japan was a laggard in the fourth quarter with its economy contracting by 0.3%. Following the massive earthquake in March, the Japanese market, as represented by the Nikkei 225 Index, dropped about 17% over a two-day period before recouping some of its losses during the following few days. Overall, the panic selling in Japan was relatively short-lived. Going forward, Japan will likely face headwinds as the earthquake and related fallout provide a further drag to the country's rate of growth.

The amazing growth story from China continued. It's economy was hardly phased by the global recession and grew 8.9% in 2009. GDP accelerated to 10.3% growth in 2010, and grew at a rate of 9.7% in the first quarter of 2011 versus the first quarter of 2010 according to a recent report from Beijing. Considering the high rate of growth, inflation was fairly well contained in 2010 but jumped to 5.4% in the latest quarter despite increasingly restrictive Chinese government policies intended to slow an economy that many fear is overheating.

Global markets have been going through an extremely tumultuous 3-year period, which saw one of the steepest declines for risk-based assets in history, followed by one of the sharpest rebounds on record. Investors, as they have done many times in the past, have looked beyond current economic conditions, which are far from robust, and have chosen to focus on the eventual recovery. As we have noted before, stock market price levels are based on the business outlook in 6-12 months.

In spite of over eight quarters of very strong performance of global stock markets, equity positions of the globally diversified investor as of March 31, 2011 have not re-attained the heights achieved at the end of the 2003-2007 bull market. Based on a weighted average of results for three broad equity indexes, the cumulative net loss since the October 2007 market top remains about -9%. However, global bonds have a cumulative net gain (i.e., total return) of approximately 23% over the same period. Thus, a bond/stock mix over the period of 50%/50% would be substantially in the black, and any portfolio strategy targeting about 30% or more in bonds would have fully recovered from the recent deep bear market by the end of March.

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		Economic Review and Market Perspective April 22, 2011

		Strong growth in emerging markets and accommodative fiscal and monetary policy have supported the global economy since the latter stages of the Bush administration, or for the last 30 months or so. The U.S. is ever so slowly entering the third stage of a three-stage recovery. First the economy was propped up by fiscal and monetary stimulus. Next came the second stage of inventory rebuilding wherein stocks intentionally allowed to diminish during the recession have been replenished, boosting economic activity, especially manufacturing. The final stage, much hoped for and just beginning, involves significant job creation and the emergence of self-sustaining final demand. During the Great Recession December 2007 to June 2009, the U.S. economy lost 8.8 million jobs. Many were manufacturing jobs that have moved offshore and probably will never return. So far, "only" 1.8 million jobs have been created since mid-2009. Thus, the recovery is not really jobless, but we have a very long way to go to restore a truly healthy U.S. job market and economy. The U.S. economic recovery, while clearly slower than desired, stayed on course in the fourth quarter of 2010 as household spending and business investment in equipment and software continued to expand, according to the minutes released by the Federal Reserve in March. While this is positive news, the Fed also expressed ongoing concern about the still high unemployment rate and inflation levels that are below acceptable levels. The Fed acknowledged that higher commodity prices have had an effect on inflation but believes that the impact will be short-lived. Accordingly, the Federal Reserve announced that it will continue to execute its plan to expand its holdings of securities. In particular, the Fed said it is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. Gross domestic product (GDP) increased at an annual rate of 3.1% in the fourth quarter of 2010, according to the third estimate released by the Bureau of Economic Analysis, a modest upward revision from the 2.8% second estimate released in February. The increase in real GDP in the fourth quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, and nonresidential fixed investment that were partly offset by negative contributions from private inventory investment and state and local government spending. Meanwhile, the Federal Reserve, through its Summary of Commentary on Current Economic Conditions ("Beige Book"), said that reports from the twelve Federal Reserve Districts indicated that overall economic activity continued to expand at a modest to moderate pace in January and early February of this year. Regarding employment, data for the first quarter were encouraging. The Bureau of Labor reported that 36,000, 192,000, and 216,000 non-farm payroll jobs were added in January, February, and March, respectively. Gains for the quarter were widespread with new jobs in manufacturing, construction, professional and business services, health care, and transportation and warehousing; many of the long-term unemployed appeared to be leaving the unemployment rolls. With the job market showing signs of improvement, commodity prices rising, the U.S. Dollar falling, and the Fed continuing to inject stimulus into the system, one has to wonder what it will take for inflation to pick up. In January, the Consumer Price Index (CPI) increased by 0.4% on a seasonally adjusted basis. In February and March, the CPI rose by 0.5%. However, the Core readings (ex food and energy) were substantially lower than the headline numbers and were reported at 0.2% for each of the first two months of this year and just 0.1% in March. As a result, the quarter's core inflation had risen only 1.2% from a year earlier. While corporate earnings have been improving, the housing market has not shown the same progress. The real estate sector remained very weak during the first quarter, especially the very important new housing component. Sales of new single-family houses declined, and existing home sales languished. Outside the U.S., overall economic growth in the fourth quarter of 2010 did not change materially from the third quarter, as austerity measures designed to improve the financial condition of various countries in the region may have influenced growth rates. According to Eurostat, the statistical office of the European Union, GDP increased by a sluggish 0.3% in the 16 countries of the Euro area. However, the region is off to a reasonably good start in 2011, as data suggested that first quarter GDP may increase by 0.8%. In contrast to European regions, Japan was a laggard in the fourth quarter with its economy contracting by 0.3%. Following the massive earthquake in March, the Japanese market, as represented by the Nikkei 225 Index, dropped about 17% over a two-day period before recouping some of its losses during the following few days. Overall, the panic selling in Japan was relatively short-lived. Going forward, Japan will likely face headwinds as the earthquake and related fallout provide a further drag to the country's rate of growth. The amazing growth story from China continued. It's economy was hardly phased by the global recession and grew 8.9% in 2009. GDP accelerated to 10.3% growth in 2010, and grew at a rate of 9.7% in the first quarter of 2011 versus the first quarter of 2010 according to a recent report from Beijing. Considering the high rate of growth, inflation was fairly well contained in 2010 but jumped to 5.4% in the latest quarter despite increasingly restrictive Chinese government policies intended to slow an economy that many fear is overheating. Global markets have been going through an extremely tumultuous 3-year period, which saw one of the steepest declines for risk-based assets in history, followed by one of the sharpest rebounds on record. Investors, as they have done many times in the past, have looked beyond current economic conditions, which are far from robust, and have chosen to focus on the eventual recovery. As we have noted before, stock market price levels are based on the business outlook in 6-12 months. In spite of over eight quarters of very strong performance of global stock markets, equity positions of the globally diversified investor as of March 31, 2011 have not re-attained the heights achieved at the end of the 2003-2007 bull market. Based on a weighted average of results for three broad equity indexes, the cumulative net loss since the October 2007 market top remains about -9%. However, global bonds have a cumulative net gain (i.e., total return) of approximately 23% over the same period. Thus, a bond/stock mix over the period of 50%/50% would be substantially in the black, and any portfolio strategy targeting about 30% or more in bonds would have fully recovered from the recent deep bear market by the end of March.

		Back to Market Reviews

Economic Review and Market Perspective April 22, 2011

Economic Review and Market Perspective
April 22, 2011