The driving force behind the economy, the consumer, may finally be approaching the "tapped out" stage. There is only so much debt that the average consumer can accumulate on low interest rate expectations and assumptions that housing prices will continue to increase at remarkable rates.
Kathleen Hays of CNN Money has written a good article analyzing the decline in consumer spending and the threats that this continued trend poses for the economy:
The threat behind consumer spending
The economy could take a huge hit, and soon, if the underlying spending trend doesn't strengthen.
October 31, 2005: 3:46 PM EST
NEW YORK (CNN/Money) - Hurricanes can bury a lot of things, but don't let them bury a very important nugget in Monday's personal income and spending report: the consumer fell off a spending cliff in August and September!
On the surface, the spending numbers look fine.
Personal spending rose 0.5 percent last month, but when the effect of soaring oil and gas prices is removed to get a "real" view of spending instead of a "nominal" reading, then the number looks pretty anemic: real spending fell 0.4 percent in September after falling by 1 percent in August.
And, given that consumer spending is about two-thirds of the economy, and given the way the government's economic math works, the economy's growth rate could actually turn negative in the fourth quarter if the consumer doesn't perk up quickly.
"Coming on the heels of a 1 percent drop in August, the two-month decline was the biggest in nearly 19 years and leaves the spending level at quarter-end well below the Q3 average," economist Dave Resler at Nomura Securities wrote in a report Monday.
"For spending to match the third-quarter level -- thereby avoiding a decline -- real spending must grow at a 3.6 percent annual rate (about 0.3 percent each month). With car sales reportedly quite weak in October, this could prove to be a rather tall order."
Now, it's true that falling auto sales had a lot to do with this. Spending on durable goods (remember? Big-ticket items built to last three years or more?) fell by 2.4 percent in September after plunging 8.9 percent in August, according to the Bureau of Economic Analysis, the economics arm of the Commerce Department.
Problem is that the early read from a lot of auto dealers this month has been another month of crummy sales. So there could more of this kind of weakness in the pipeline.
What about spending on other stuff you say? Certainly people buy a lot more than cars. Yes they do and unfortunately, when you adjust again for inflation, mainly boosted by energy prices right now, you see that it's not just autos that consumers are shying away from.
Purchases of "non-durable" goods -- less durable items like clothing, books, DVDs, etc. -- fell by 1 percent in September after rising a mere 0.1 percent in August.
Only spending on services was growing, and that's the category that includes visits to the doctor's office, lawyers' fees, financial services, etc.: up 0.3 percent in September on top of an increase of 0.2 percent the month before.
Nomura's Resler says if the consumer fails to shift back into a higher spending gear, the Fed will take note, if not tomorrow, then surely in December at its final meeting of the year.
"Unless spending (primarily ex-autos) stages a rather convincing recovery in the next few weeks, the prospect of the first quarterly decline in consumer spending in 15 years could factor into the December 13 FOMC decision," Resler wrote, referring to the Federal Open Market Committee, the Fed's policy-making arm.
According to some economists, it all depends on the job market.
"Consumer spending is unlikely to slow by enough to materially harm the overall economy, if, as expected, the unemployment rate resumes its downward trend in 2006," is the view of Jon Lonski of Moody's Investor's Service.
A possible assist for the consumer could be shaping up in the steady drop in gas prices at the pump as the impact of the hurricanes pass and as crude oil prices fall back near $60 a barrel.
The problem is, in the view of Dave Gilmore of FXA up in Connecticut, that the Fed is raising interest rates, bond yields are rising finally as a result, and if energy prices keep falling and give the consumer some relief -- and the economy a bounce -- that could encourage even more rate hikes.
"Yes, the U.S. consumer is quite vulnerable to rising market rates...the home ATM machine gets gummed up if rising mortgage rates lead to a correction in the U.S. housing market," he said.
Remember, the Fed has been raising short-term rates since June of 2004 but the long-term, bond-market rates that determine mortgage rates have stayed relatively low -- until the Fed's last rate hike in September.
"If bond yields keep rising which I think they will, then not even stocks are safe from a welcome decline in energy prices," observes Gilmore. "In this case lower energy prices could prove to be a Trojan horse unleashing a problematic rise in market rates."
Monday, October 31, 2005
Bernanke Realities
With the recent appointment of Ben Bernanke as Greenspan's successor, the markets have largely applauded the appointment. How important was this appointment? It was only important in the sense that it quelled any fears that investors may have had after the questionable nomination of Harriet Miers for the Supreme Court.
Allan Sloan of Newsweek wrote a terrific article that discusses Bernanke's challenges ahead amidst the global realities of a less effective Federal Reserve:
Opinion: Reality Check on the Fed
The nation's central bank hates inflation, except the kind that's puffed up its reputation as an all-powerful agency.
By Allan Sloan
Newsweek
Nov. 7, 2005 issue - We all like to believe that there's an all-knowing, all-powerful force looking after us. No, I'm not talking about organized religion and God. I'm talking about the widespread belief that an all-powerful Federal Reserve Board controls interest rates and inflation, and is looking out for each and every one of us.
Since President Bush nominated Ben Bernanke to become the next Alan Greenspan, we've heard endlessly about the Fed's powers over the financial markets and the economy, and about how hard it will be for Cousin Ben to fill Uncle Alan's shoes. But despite the outsize attention that any utterance from the head Fed typically gets, the economic world isn't controlled by one person, or even one institution.
Bernanke will be a powerful guy, of course, and well worth watching and listening to. But you've got to remember two things about the Fed. First, it's not looking after your personal interests—it's looking after the financial system, which isn't the same thing. A for-instance: in the early 1990s, when many major banks were effectively insolvent, the Fed bailed them out by lowering short rates, handing them huge profits at the expense of people who depended on CD income for food money.
Second, the Fed is far from all powerful. In fact, it's considerably less powerful than it was when Greenspan took the helm in 1987. Since then, the United States has become dependent on the rest of the world—especially the central banks of Japan and China and other Asian countries—to finance our budget and trade deficits. If Asia grows less eager to hold dollars, U.S. interest rates will rise, regardless of the Fed's wishes.
On the U.S. domestic front, our largely deregulated financial system is far harder for the Fed to influence than the old regulated system was. When interest rates paid to depositors were regulated, the Fed could raise short rates, lure money out of banks into Treasury bills and slow down bank lending. Now, with no interest-rate ceilings and such nonbank lenders as hedge funds abounding, the Fed's influence has waned.
The one important interest rate that the Fed controls—the federal funds rate—drives short-term interest rates. But the fed funds rate doesn't drive long-term rates, which are set by financial markets and are more important to businesses and home buyers than short rates are. In fact, during Bernanke's stint as a Fed governor, he tried to talk down long-term rates by threatening to have the Fed print money to buy up long-term bonds. Had that happened, the markets would have bested the Fed the way they bested the Bank of England in 1992 when it spent billions trying to defend the British pound. He raised a hue and cry about the prospect of deflation, but it never appeared.
The fact that Bernanke isn't perfect shouldn't be cause for alarm. Neither is Greenspan, as he'd be the first to admit if you bought him a couple of beers and promised him anonymity. He's been very good. But the stock bubble grew and burst on his watch, and we've now got a housing bubble that will inevitably burst. Last year, Greenspan talked about how foolish home buyers had been to get fixed-rate mortgages rather than variable-rate ones—but given the sharp rise in short rates, anyone who switched to a floating-rate loan is wailing the blues today.
What I like best about Greenspan is that he plays things by ear and won't say what he's really up to. That magnifies the Fed's influence by keeping big market players off balance. The players care only about making money, but the financial system needs balance, which the Fed provides. With the Fed less powerful than it once was, guile is good.
We won't know how effective a Fed chairman Cousin Ben is until after his first crisis. But one thing we know already: a divinity, he's not.
© 2005 Newsweek, Inc
Allan Sloan of Newsweek wrote a terrific article that discusses Bernanke's challenges ahead amidst the global realities of a less effective Federal Reserve:
Opinion: Reality Check on the Fed
The nation's central bank hates inflation, except the kind that's puffed up its reputation as an all-powerful agency.
By Allan Sloan
Newsweek
Nov. 7, 2005 issue - We all like to believe that there's an all-knowing, all-powerful force looking after us. No, I'm not talking about organized religion and God. I'm talking about the widespread belief that an all-powerful Federal Reserve Board controls interest rates and inflation, and is looking out for each and every one of us.
Since President Bush nominated Ben Bernanke to become the next Alan Greenspan, we've heard endlessly about the Fed's powers over the financial markets and the economy, and about how hard it will be for Cousin Ben to fill Uncle Alan's shoes. But despite the outsize attention that any utterance from the head Fed typically gets, the economic world isn't controlled by one person, or even one institution.
Bernanke will be a powerful guy, of course, and well worth watching and listening to. But you've got to remember two things about the Fed. First, it's not looking after your personal interests—it's looking after the financial system, which isn't the same thing. A for-instance: in the early 1990s, when many major banks were effectively insolvent, the Fed bailed them out by lowering short rates, handing them huge profits at the expense of people who depended on CD income for food money.
Second, the Fed is far from all powerful. In fact, it's considerably less powerful than it was when Greenspan took the helm in 1987. Since then, the United States has become dependent on the rest of the world—especially the central banks of Japan and China and other Asian countries—to finance our budget and trade deficits. If Asia grows less eager to hold dollars, U.S. interest rates will rise, regardless of the Fed's wishes.
On the U.S. domestic front, our largely deregulated financial system is far harder for the Fed to influence than the old regulated system was. When interest rates paid to depositors were regulated, the Fed could raise short rates, lure money out of banks into Treasury bills and slow down bank lending. Now, with no interest-rate ceilings and such nonbank lenders as hedge funds abounding, the Fed's influence has waned.
The one important interest rate that the Fed controls—the federal funds rate—drives short-term interest rates. But the fed funds rate doesn't drive long-term rates, which are set by financial markets and are more important to businesses and home buyers than short rates are. In fact, during Bernanke's stint as a Fed governor, he tried to talk down long-term rates by threatening to have the Fed print money to buy up long-term bonds. Had that happened, the markets would have bested the Fed the way they bested the Bank of England in 1992 when it spent billions trying to defend the British pound. He raised a hue and cry about the prospect of deflation, but it never appeared.
The fact that Bernanke isn't perfect shouldn't be cause for alarm. Neither is Greenspan, as he'd be the first to admit if you bought him a couple of beers and promised him anonymity. He's been very good. But the stock bubble grew and burst on his watch, and we've now got a housing bubble that will inevitably burst. Last year, Greenspan talked about how foolish home buyers had been to get fixed-rate mortgages rather than variable-rate ones—but given the sharp rise in short rates, anyone who switched to a floating-rate loan is wailing the blues today.
What I like best about Greenspan is that he plays things by ear and won't say what he's really up to. That magnifies the Fed's influence by keeping big market players off balance. The players care only about making money, but the financial system needs balance, which the Fed provides. With the Fed less powerful than it once was, guile is good.
We won't know how effective a Fed chairman Cousin Ben is until after his first crisis. But one thing we know already: a divinity, he's not.
© 2005 Newsweek, Inc
Thursday, October 27, 2005
The Cheque is in the Mail
Many clients have been receiving cheques from various mutual fund companies over the last month. As expected, I have received a flood of phone calls from clients asking about the money received.
The cheques were sent as part of a settlement between various Mutual Fund Companies and the Ontario Securities Commission for "Market Timing" issues that were discovered from an OSC investigation. The OSC defines Market Timing as follows:
Market timing involves short-term trading of mutual fund securities to take advantage of short term discrepancies between the "stale" values of securities within a mutual fund's portfolio and the current market value of those securities. Stale values can occur in mutual fund portfolios comprised, in whole or in part, of non-North American foreign equities. Stale values of those securities may result in stale values of the units of a mutual fund as a result of the way in which the net asset value of most mutual funds is calculated for the purpose of determining the price at which an investor may buy or sell a unit of the fund.
A market timer will attempt to take advantage of the difference between the "stale" value and an expected price movement of a fund the following day by trading in anticipation of those price movements.
The Harm Caused by Frequent Trading? When certain investors engage in frequent trading market timing in foreign funds, and when those investors are not required to pay a proportionate fee to the fund, the economic interest of long-term unitholders of these foreign funds is adversely affected. Significant harm may be incurred by a fund in which frequent trading market timing occurs. Any such harm would be borne by all investors in the fund. In addition to dilution, market timing in a fund also may result in certain inefficiencies in that fund. Those inefficiencies, which will vary depending upon the particular fund, may involve increased transaction costs and disruption of a fund's portfolio management strategy (including the maintenance of cash or cash equivalents and/or monetization of investments to meet redemption requirements) and may impair a fund's long-term performance.
If you would like to know more about the Market Timing investigation, please visit the following link:
http://www.osc.gov.on.ca/HotTopics/FundSettle/fs_backgrounder.jsp
If you have any further questions, please call me.
The cheques were sent as part of a settlement between various Mutual Fund Companies and the Ontario Securities Commission for "Market Timing" issues that were discovered from an OSC investigation. The OSC defines Market Timing as follows:
Market timing involves short-term trading of mutual fund securities to take advantage of short term discrepancies between the "stale" values of securities within a mutual fund's portfolio and the current market value of those securities. Stale values can occur in mutual fund portfolios comprised, in whole or in part, of non-North American foreign equities. Stale values of those securities may result in stale values of the units of a mutual fund as a result of the way in which the net asset value of most mutual funds is calculated for the purpose of determining the price at which an investor may buy or sell a unit of the fund.
A market timer will attempt to take advantage of the difference between the "stale" value and an expected price movement of a fund the following day by trading in anticipation of those price movements.
The Harm Caused by Frequent Trading? When certain investors engage in frequent trading market timing in foreign funds, and when those investors are not required to pay a proportionate fee to the fund, the economic interest of long-term unitholders of these foreign funds is adversely affected. Significant harm may be incurred by a fund in which frequent trading market timing occurs. Any such harm would be borne by all investors in the fund. In addition to dilution, market timing in a fund also may result in certain inefficiencies in that fund. Those inefficiencies, which will vary depending upon the particular fund, may involve increased transaction costs and disruption of a fund's portfolio management strategy (including the maintenance of cash or cash equivalents and/or monetization of investments to meet redemption requirements) and may impair a fund's long-term performance.
If you would like to know more about the Market Timing investigation, please visit the following link:
http://www.osc.gov.on.ca/HotTopics/FundSettle/fs_backgrounder.jsp
If you have any further questions, please call me.
Clone Funds - R.I.P. Now What?
Over the past few months, clone funds have been steadily "wound down" due to the elimination of the RSP foreign content rules. Investors, that wished to maximize their foreign content within their RRSP, used clone funds, to bypass the foreign content rule. The cost of the forward contracts, associated with clone funds, made them slightly more expensive than the underlying funds. However, with the elimination of the foreign content constraints, investors can have 100% of their money outside of Canada at no additional cost.
The traditional perspective has always been that Canada represents approximately 3% of world Gross Domestic Product (GDP) and therefore you shouldn't have more than 3% of your investments in Canada, as there are better opportunities elsewhere in the world. Over the last few years, however, this would not have been the case. As the Canadian dollar has appreciated, it has done severe damage to rates of return in U.S. investments, as the returns were converted from U.S. to Canadian Dollars. Also, as China's economic expansion has exploded, the demand for Canadian resources has elevated the Canadian economy and created impressive rates of return for Canadian stocks in the energy, financial, and materials sectors.
The temptation for investors is to eliminate their "global focus" and flock back to Canadian investments to eliminate potential currency risks and to enjoy the benefits of the global expansion through the natural appreciation of Canadian resource and materials companies.
I would suggest that many of the companies in these sectors have already reached or at least approached "fair value" and the future potential gains that may be enjoyed pale in comparison to other global stocks that have lagged in performance in recent years.
The timing of the elimination of the Foreign Content Rule makes for some very interesting investment allocation decisions going forward. Logically, investors understand the need for global diversification but they may find it hard to ignore the recent surge in the Canadian stock market.
Stay tuned...
The traditional perspective has always been that Canada represents approximately 3% of world Gross Domestic Product (GDP) and therefore you shouldn't have more than 3% of your investments in Canada, as there are better opportunities elsewhere in the world. Over the last few years, however, this would not have been the case. As the Canadian dollar has appreciated, it has done severe damage to rates of return in U.S. investments, as the returns were converted from U.S. to Canadian Dollars. Also, as China's economic expansion has exploded, the demand for Canadian resources has elevated the Canadian economy and created impressive rates of return for Canadian stocks in the energy, financial, and materials sectors.
The temptation for investors is to eliminate their "global focus" and flock back to Canadian investments to eliminate potential currency risks and to enjoy the benefits of the global expansion through the natural appreciation of Canadian resource and materials companies.
I would suggest that many of the companies in these sectors have already reached or at least approached "fair value" and the future potential gains that may be enjoyed pale in comparison to other global stocks that have lagged in performance in recent years.
The timing of the elimination of the Foreign Content Rule makes for some very interesting investment allocation decisions going forward. Logically, investors understand the need for global diversification but they may find it hard to ignore the recent surge in the Canadian stock market.
Stay tuned...
Wednesday, October 26, 2005
Welcome to my Blog!
After spending over a month researching, creating, and tweaking my most recent newsletter, I realized why I write so few newsletters....they take too long to publish and often the timeliness of the information is less effective and relevant than I would like.
Every day, seven days a week, I have the same routine. I spend approximately 1 hour during the morning and 1 hour every evening, researching timely and relevant economic and political articles from various sources around the world. I also attend many conferences to hear views directly from Economists, Mutual Fund Managers, and other financial experts. I do this for the purpose of disseminating information that may ultimately affect my client's investment portfolios. While every client is different and each portfolio is created in a custom manner to reflect their individual goals, timelines, risk tolerances, the macroeconomic and political factors that affect them are the same.
By creating this blog, I hope to share more information that can be useful in "real time" so that my clients can understand what my current thoughts are regarding various financial issues and therefore they can make better decisions in working with me.
I encourage you to visit this site often and to share your comments.
Thank you.
Every day, seven days a week, I have the same routine. I spend approximately 1 hour during the morning and 1 hour every evening, researching timely and relevant economic and political articles from various sources around the world. I also attend many conferences to hear views directly from Economists, Mutual Fund Managers, and other financial experts. I do this for the purpose of disseminating information that may ultimately affect my client's investment portfolios. While every client is different and each portfolio is created in a custom manner to reflect their individual goals, timelines, risk tolerances, the macroeconomic and political factors that affect them are the same.
By creating this blog, I hope to share more information that can be useful in "real time" so that my clients can understand what my current thoughts are regarding various financial issues and therefore they can make better decisions in working with me.
I encourage you to visit this site often and to share your comments.
Thank you.
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