3/8/13

U.S. Unemployment Improves in February:

Payrolls increased more than forecast in February and the jobless rate unexpectedly fell to a five-year low of 7.7 percent, a sign U.S. employers were undaunted by the budget impasse in Washington. Employment rose 236,000 last month after a revised 119,000 gain in January that was smaller than first estimated, Labor Department figures showed today.  Hiring in construction jumped by the most in almost six years. In addition to the pickup in construction employment, payrolls climbed at retailers, professional and business services such as temporary help firms, and at health care providers.  However, the participation rate, which indicates the share of working-age people in the labor force, dropped to 63.5 percent, matching the lowest since September 1981, from 63.6 percent.  The problem with this is that as more individuals who had previously given up on getting a job (or don’t have any motivation due to extended unemployment benefits) come back into the pool of workers it will take an increasing number of new jobs added each month to keep the unemployment rate from moving back up.  Overall the progress on jobs is welcome news but we will need to see at least this number of new jobs for many months to reduce unemployment in any meaningful way.  The economists are also reducing their payroll projections due to the impending spending cuts from the sequester that Congress is negotiating right now.  Federal Reserve officials have said they will keep their benchmark lending rate near zero as long as unemployment remains above 6.5 percent and inflation is projected to be no more than 2.5 percent. They also said during a January meeting they would keep buying $40 billion per month in mortgage bonds and $45 billion in Treasuries.

“Consistent with the moderate pace of economic growth, conditions in the labor market have been improving gradually,” Fed Chairman Ben S. Bernanke told lawmakers last week during his semiannual testimony on monetary policy. Central bank officials still want to see “substantial improvement in the outlook for the labor,” he said.

Bank Stress Tests:

The Federal Reserve completed its latest “stress tests” on large U.S. Banks.  All but one of the nation’s 18 biggest banks could survive a severe recession and still have enough capital to keep lending, the Federal Reserve said Thursday.  The only one that did not pass was Ally Financial (the old GMAC).  The stress tests are designed to determine how the banks would hold up under a severe downturn in the economy.  The “stress test” used the following assumptions: as a whole, the banks would lose $462 billion over nine quarters from a combination of loan write-downs and the falling value of securities, in a recession where unemployment hit nearly 12%, stocks lost half of their value and home prices dropped 20%.  This shows that the big banks have re-built their capital base after the financial crisis of 2008.  This is a remarkable achievement that is largely due to the TARP program (politically referred to as the bank bailout).  Almost every bank has paid back their loans at a profit to U.S. taxpayers.  Banks bolstered their capital in the last year by retaining their profits and shedding risky or non-performing assets.  Now the politics comes back in as the banks must “ask” if they can issue or raise dividends and buy back shares.  We think that the Federal Reserve will allow many of the banks to start returning capital to investors which will be positive for bank stocks.  Lending is improving across the board and when interest rates rise the “spreads” banks earn on loans will increase earnings.  The U.S. economic recovery will benefit as lending standards start to ease up to allow businesses to fund growth initiatives.

Individual Investors are still nervous:

In last week’s poll from the American Association of Individual Investors (AAII), bullish sentiment saw its largest weekly decline since November 2010 as investors were clearly rattled by the equity market’s reaction to the inconsistent comments from the Federal Reserve officials and the Italian elections.  Fast forward one week later and the S&P 500 is trading at new highs.  With the market’s nice move higher in 2013 you would think individual investor’s confidence in the market would be moving much higher but it has not.  The “retail” or small investor has waited too long to get back into the markets and is still sitting on a lot of cash due to all the noise from U.S. politics and the European debt issues.  Institutional investors use the AAII poll as an inverse indicator for the market.  They want to be buying when the individual investor is nervous and selling when the small investors are overly confident.  While the stock market has recovered all of its loses from 2008 it by no means has run too far as valuations are still attractive due to the fact that earnings are much higher than they were at the last market peak in 2007 and individual investors are still not back in the market.  Small investors have been slow to embrace equities, and even after they commit, they are very nervous about their investing decisions due to the pain they experienced in 2008.  The next leg up in the market will depend on several things;  earnings and economic data must continue to move forward.  The individual investor may soon “capitulate” and move their cash and government bond investments back into equities.

We should still expect some periods of short term selling on any bad news on global economic growth, U.S. political dysfunction or a setback in the European recovery.  However, individual investors have trillions of dollars that will eventually be forced out of cash and Treasury Bonds which should provide a significant catalyst for stocks in the foreseeable future.

The table below shows the year-to-date performance of different asset classes thus far in 2013.  While large cap U.S. stocks in the Dow Jones Industrial Average and S&P 500 have done very well thus far, bonds, commodities, emerging markets and International stocks have underperformed.  Our long term investment discipline is centered on broadly diversified asset allocation which reduces overall risk and therefore we are not going to match the performance over all short term time periods of an index that is 100% U.S. large cap stocks such as the Dow or S&P 500.  However, over the long term the performance data is conclusive that our broad based asset allocation investment philosophy provides the best risk/return results for investors.

 

Index

YTD Return (as of 3/7)

Index

YTD Return (as of 3/7)

Dow Jones Ind. Average

9.91%

S&P 500

8.74%

S&P 400 Mid Cap

10.17%

Russell 2000 Small Cap

10.23%

Barclays US Agg Bond

-0.56%

MSCI World ex-US

4.78%

Barclays US Gov’t Bond

-0.65%

MSCI Emerging Markets

0.26%

MSCI US REIT

6.22%

Dow Jones UBS Commodity

-1.65%