Weekly Commentary December 29th, 2014

The Markets

With gas hovering around $2 a gallon in many parts of the country, chances are you’re smiling every time you fill up the tank.

The oil price drop, which is one of the biggest stories of 2014, is a twist on a familiar tale. Rising supply (production in non-OPEC countries, like the United States, increased) and falling demand (in Europe, Japan, and China) caused prices to move lower. In this case, they’ve moved a lot lower. Last summer, the price of crude oil was about $107 a barrel. Last week, it finished below $55 a barrel.

Overall, according to the International Monetary Fund (IMF), lower oil prices are expected to be good news for the global economy. They’re expected to have economic benefits for countries that import a lot of oil, like China and India. They also are a boon for U.S. consumers who have more money in their pockets when they pay less at the pump.

However, low oil prices aren’t good for everyone. In the United States, oil-producing states like Texas, Louisiana, Wyoming, Oklahoma, and North Dakota may lose jobs and tax revenues. Outside the United States, oil exporters like Russia, Iran, Nigeria, and Venezuela are likely to suffer adverse consequences as a result of falling prices, including domestic unrest, according to MarketWatch.com. The International Energy Agency (IEA) said,

“…For producer countries, lower prices are a negative:  the more dependent on oil revenues they are and the lower their financial reserves, the more adverse the impact on the economy and domestic demand. Russia, along with other oil-dependent but cash-constrained economies, will not only produce less but is likely to consume less next year.”

The supply and demand equation isn’t likely to change soon. The IEA forecasts global demand growth will be relatively weak during 2015. Meanwhile, the Organization of the Petroleum Exporting Countries (OPEC) has done nothing to reduce supply, largely because of Saudi Arabia which is the second largest oil producer in the world. Saudi has reserves that make it better able to absorb the oil price shock than other oil exporters. It also has political motivations to keep oil prices low. These include punishing Iran and Russia for supporting Bashar Assad in the Syrian Civil War, according to the International Business Times.

If you want to know where oil prices may go, keep an eye on Saudi Arabia.

It’s not the 1 percent, it’s the 0.1 percent. They say history repeats itself. That seems to jibe with the findings of a brand new paper by Emmanuel Saez of the University of California, Berkeley, and Gabriel Zucman of the London School of Economics.

“Wealth concentration has followed a U-shaped evolution over the last 100 years: It was high in the beginning of the twentieth century, fell from 1929 to 1978, and has continuously increased since then. The rise of wealth inequality is almost entirely due to the rise of the top 0.1% wealth share, from 7% in 1979 to 22% in 2012—a level almost as high as in 1929… The increase in wealth concentration is due to the surge of top incomes combined with an increase in saving rate inequality.”

The pair found that the average real growth rate of wealth for the 160,000 families that comprise the top 0.1 percent was 1.9 percent from 1986 to 2012. As it turns out, income inequality has a snowballing effect on wealth distribution. The wealthiest people earn top incomes and save at high rates, which helps concentrate greater wealth in the hands of a few. It’s interesting to note that top wealth-holders are younger today than they were in the 1960s.

In contrast, the riches of the bottom 90 percent did not grow at all from 1986 to 2012. Historically, the share of wealth divvied up among this group grew from 20 percent in the 1920s to 35 percent in the 1980s. However, by 2012, it had fallen to 23 percent. Pension wealth grew during the period, but not enough to offset the rapid growth of mortgage, consumer credit, and student loan debt.

 

Weekly Focus – Think About It

"History repeats itself, but the special call of an art which has passed away is never reproduced. It is as utterly gone out of the world as the song of a destroyed wild bird.

--Joseph Conrad, Polish author

Effects of Lower Oil Prices

Oil prices may be turning into the Grinch of this holiday season. Oil has dropped by more than 40% in just the past three months and contributed to volatile stock markets. I do not believe the sharp drop in oil prices is a sign of significant deterioration in the U.S. or global economy. The stunning collapse does have wide-ranging impacts on the economy and markets, but I believe the risks associated with low oil prices can be manageable and that the positives outweigh the negatives.

Lower oil prices benefit the U.S. economy in a number of ways. By saving U.S. consumers tens of billions of dollars at the gas pump and in home energy bills, it is estimated that the $50-plus drop in the price of oil since June 2014 boosts U.S. gross domestic product by roughly 0.5%. That is significant, but it is important to keep in mind that U.S. consumer spending totals $12 trillion per year, and that consumers spend an average of just 4% of their incomes on energy. Still, this is a benefit to consumers, especially for those at lower income levels who spend a bigger portion of their incomes on energy.

The U.S. manufacturing sector is also a beneficiary of lower energy costs. Although not nearly as energy intensive as they used to be, industrial companies benefit from lower oil prices via lower transportation and production costs. Just a penny drop in fuel prices can save tens of millions of dollars for an airline. And lower oil and other commodity prices mean lower raw material costs.

These are all good things, but there are offsetting factors. Lower energy prices will slow—but not stop—the U.S. energy renaissance. Less U.S. energy production may mean slightly fewer energy jobs (energy jobs are about 2% of total U.S. jobs) and less business investment for future projects or expansion. The oil and gas industry drives a significant portion of business investment, so services, equipment, and infrastructure companies that service the oil producers will feel some impact.

Sharply lower oil has already impacted financial markets. The roughly 20% drop in the S&P 500 energy sector, which composes 8.3% of the S&P 500, may continue to drive increased volatility for the broad stock market indexes. The fixed income markets are also impacted, as energy composes about 15% of the high-yield bond benchmark, the Barclays High Yield Bond Index. Lower oil prices are likely to crimp profitability and may impact the ability of weaker companies to meet their debt obligations. However, it is expected that much of this negative impact is factored into market prices, and widespread defaults across the sector are not expected, should oil prices stabilize somewhere near current prices.

Most importantly, the U.S. economy is doing quite well and I think it may get a bit better in 2015, as I will highlight in our Economic Outlook 2015: In Transit. I do not believe oil’s sharp decline should be interpreted as a sign that an economic downturn is forthcoming. It is very difficult to predict where oil prices are going from here, but the oil market has likely overreacted to supply pressures and should begin to stabilize over the next several months, as lower prices help buoy demand and discourage some of the higher cost production. Although the severity of the drop in oil prices has been alarming and brings some risk to markets, at this point, in terms of what it means for the economy, I believe the positives outweigh the negatives.

Weekly Commentary December 22nd, 2014

The Markets

Geopolitics and monetary policy and deflation! Oh my!

It was a wild, wild week. First, the Russian central bank announced a massive rate hike and the country’s main deposit rate rose from 10.5 percent to 17 percent. The move was the largest single increase in Russian rates “since 1998, when Russian rates soared past 100 percent and the government defaulted on debt,” according to Bloomberg.com.

The central bank was desperately trying to shore up the ruble which was suffering from lower oil prices and Western sanctions imposed after Russian annexed Crimea. The rate hike wasn’t immediately effective and the ruble sank to a record low. The currency has lost 52 percent of its value during 2014 to date, and the outlook for the future of the country’s economy isn’t bright. If oil averages $60 a barrel, Russia’s gross domestic product – the value of all goods and services produced in the country – might fall by 4.5 percent to 4.7 percent in 2015.

Events in Russia put investors in a selling mood, and stock markets around the world moved lower early in the week. Barron’s commented, “From all appearances, investors were selling stocks while they were doing their holiday shopping.”

The investor stampede was headed off by a bit of whooping and hollering from the Federal Reserve. After the Federal Open Market Committee meeting, the Fed announced its policies remained unchanged:

“…Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.”

The Fed’s decision was enough to calm markets, many of which showed attractive gains by week’s end.

as people get richer, do investment returns get better? No, they don’t. Research shows there is a negative correlation between gross domestic product (GDP) per capita – a measure of how wealthy people in a country are becoming – and investment returns.

In other words, the countries with the fastest growing economies don’t always produce the highest investment returns and vice versa. For example, between 1900 and 2013, South Africa rewarded investors with long-term stock market returns of about 7.4 percent while its per capita GDP growth was 1.1 percent. At the opposite end of the spectrum was Ireland, where markets returned 2.8 percent while per capita GDP growth was 4.1 percent. The Economist described the research findings:

“The quintile of countries with the highest growth rate over the previous five years produced average returns over the following year of 6 percent; those in the slowest-growing quintile produced returns of 12 percent... Why might this be? One likely explanation is that growth countries are like growth stocks; their potential is recognized and the price of their equities is bid up to stratospheric levels. The second is that a stock market does not precisely represent a country's economy – it excludes unquoted companies and includes the foreign subsidiaries of domestic businesses. The third factor may be that growth is siphoned off by insiders – executives and the like – at the expense of shareholders.”

Here is another interesting economic tidbit. While past economic growth does not predict future equity market performance, changes in stock prices do correlate to future economic growth. That’s because expectations play an important role in markets. The expectation of poor future economic performance may cause a country’s share values to fall, and vice versa. A research report from Schroders said, “If expectations are key, a poor economic outlook will already be priced in, and investors’ returns will depend instead upon whether market expectations are overly optimistic or pessimistic with regards to future GDP growth.”

 

Weekly Focus – Think About It

"Not everything that can be counted counts, and not everything that counts can be counted."

--Albert Einstein, Theoretical physicist

Weekly Commentary December 15th, 2014

The Markets

Ouch!

It was no fun to be an investor last week. The week prior, a commentary in The Wall Street Journal’s blog, MoneyBeat, offered this insight:

“Falling oil prices are thought to be good for stocks because they stimulate consumer spending and hold down inflation. The lower costs support economic growth, boost corporate earnings, and lessen pressure on the Federal Reserve to raise interest rates. The stock market loves that mix.”

That was not the case last week. A selling spree, sparked in part by concerns related to energy, led to virtually every major world stock index (every one that Barron’s follows, anyway) moving lower. The single exception was the Shanghai Composite and that was flat.

It seems the International Energy Agency’s prediction that demand for energy would grow more slowly in 2015, combined with the fact supply of some resources has been growing, addled investors and they sold everything but the kitchen sink. Even industries that may be helped by lower energy costs – consumer goods, consumer services, health care, and others – lost value. In the United States, stock markets delivered their worst performance in more than three years, according to Barron’s.

Have investors lost sight of the fact the United States has a consumption-driven economy?

The Federal Reserve Bank of St. Louis reported personal consumption – how much Americans are spending on goods and services – was 70 percent of gross domestic product (the value of all goods and services produced) in the United States during the third quarter of 2014. Lower energy prices tend to put more money in the pockets of consumers so they can spend more and that can help the economy grow. In fact, U.S. News reported, “…approximately every penny decline in the price of a gallon of gasoline translates to about $1 billion in additional disposable income for American households.”

It’s interesting to note consumers – a group that overlaps with investors in a Venn diagram – are more confident than they have been in almost eight years, according to data released by the University of Michigan and cited by Barron’s.

what does the future hold? The good news is most analysts expect economic growth in the United States to continue. The Wall Street Journal, The Economist, The Federal Reserve, and the International Monetary Fund all have forecast gross domestic product growth in the United States at 2.5 to 3.0 percent for 2015. That’s not quite as good as the 7 percent growth forecast for China or the 6.5 percent growth estimated for India, but it’s decent for a developed nation with a mature economy.

There are factors that could hurt the economic outlook in the United States. Economists participating in The Wall Street Journal’s Economic Forecasting Survey said a negative global event was the biggest threat to U.S. economic growth followed by slower global growth. Three of the risks The Economist believes could keep companies from operating at target profitability during 2015 include:

·         Deflation in the Eurozone: “A Japanese-style stagnation in the euro zone would have profoundly negative implications for global demand, especially at a time when growth in the emerging markets is also softening.”

·         Spillover from Syria’s Civil War: “…The prospect of [ISIS] diverting its energies from Iraq and into Syria and its neighbors (such as Lebanon and Jordan) could prompt an uptick in oil's political risk premium once more.”

·         Escalation of the Russia-Ukraine conflict: “…The recently imposed trade restrictions have not only plunged Russia into recession, but also contributed to sinking industrial output in Germany… further sanctions could see Russia cutting off natural gas sales to Ukraine or the European Union (as is currently already reportedly occurring with supplies to Poland)… [these acts] would no doubt have a deleterious impact on the [Euro] region's economic recovery.”

There are also factors that could improve the outlook. The Wall Street Journal’s survey found economists believe tightening labor markets, higher wages, better consumer spending, and low energy prices could support U.S. economic growth during 2015.

 

Weekly Focus – Think About It

“The way a team plays as a whole determines its success. You may have the greatest bunch of individual stars in the world, but if they don't play together, the club won't be worth a dime.

--Babe Ruth, American baseball player

Weekly Commentary December 8th, 2014

The Markets

In the United States, it was more of the same ole, same ole…

The Dow Jones Industrial Average and Standard & Poor’s 500 closed at record highs for the 34^th time and 49^th time this year, respectively. The impetus last week was a jobs report that far exceeded expectations. For the 10^th consecutive month, more than 200,000 jobs have been created. That’s the longest string of improvements since 1994, according to Reuters. Not only did U.S. employers hire the most new workers in three years, wages ticked higher, too. An expert cited by Barron’s said the underlying report data was promising:

“The average workweek was 34.6 hours, up from 34.5, and where it was before the 2008 crisis. That level acts as an effective ceiling to additional hours and suggests employers will have to increase hiring, he says – hence the pop in bond yields. The 10-year U.S. Treasury bond yield jumped to 2.31 percent from 2.26 percent on Friday. (Bond prices move inversely to yields.)”

Analysts told CNBC.com the strong jobs report might mean the Federal Reserve will begin to raise the Fed funds rates by mid-2015.

The Stoxx Europe Index closed at a relatively high level, even though things weren’t so rosy economically in the Eurozone. Inflation continued to fall and is now close to zero. The last time inflation was at 2 percent, which is the level targeted by the European Central Bank (ECB), was two years ago, according to The New York Times.

The ECB continues to talk a big game without taking any action, according to Barron’s. Last week, President Mario Draghi said the ECB plans to assess the success of its current stimulus programs as well as the effects of lower energy prices early in 2015. However, he offered no specific monetary easing measures or a timeline for action. It was the same message he delivered in October and November of 2014. Experts cited by The New York Times indicated the ECB could lose credibility if it fails to act early next year.

pondering the effects of long working hours. In 1960, about one-half of the jobs in the United States were at least mildly physically strenuous. Gosh, how things have changed. Today, we’re a lot more sedentary. Just 20 percent of jobs are at all strenuous and has produced the wrong type of growth, according to Joelle Abramowitz, an economist at the U.S. Census Bureau and author of a paper entitled, The connection between working hours and body mass index in the U.S.: a time use analysis.

Abramowitz found 70 percent or more of people who work 40 or more hours a week are overweight. All those extra hours people put in trying to impress the boss, or wining and dining clients, don’t pay off when it comes to maintaining a healthy weight. For every 10 hours worked – over and above the weekly 40 – at a non-strenuous job, men gain about 1.4 pounds and women gain about 2.5 pounds. The Economist theorized longer work hours might translate into less exercise time, more take-out meals, and fewer hours of sleep. All of these have the potential to affect weight.

In a separate article, The Economist pointed out there has been a significant shift in the leisure time of the rich and the poor. One expert cited said, “In the 19th century you could tell how poor somebody was by how long they worked.” That has changed over time. In 1965, college-educated men, who tended to earn more than men without college degrees, had more leisure time than men with only high school diplomas. By 2005 the college-educated enjoyed eight hours less leisure time each week than the high school grads.

It’s interesting to note less than 60 percent of Americans who work 20 or fewer hours a week are overweight.

Weekly Focus – Think About It

“The best remedy for those who are afraid, lonely or unhappy is to go outside, somewhere where they can be quiet, alone with the heavens, nature, and God. Because only then does one feel that all is as it should be.”

--Anne Frank, Writer

Weekly Commentary December 1st, 2014

The Markets

If investors around the world were voting on their favorite stock market, there is little doubt U.S. markets would finish near the top. Barron’s explained, “For the past three years, Wall Street has been trouncing the world’s other markets, inducing investors to pile in and bail on other assets.”

So, how popular are U.S. markets? The Standard & Poor’s 500 Index (S&P 500) has not moved lower for four consecutive days during 2014, according to experts cited by Barron’s. That breaks S&P 500’s previous record for longest period in a calendar year without four down days in a row which happened in 1997. The streak ended in late August of that year.

In September, more than $164 billion were invested in the United States by investors at home and abroad. The reason investors are attracted to U.S. markets is no secret. Last week’s economic data may have been mixed, but it didn’t change the fact U.S. economic growth has been relatively strong. Third quarter’s gross domestic product – the value of all goods and services produced in the United States – was revised higher last week from 3.5 percent to 3.9 percent. Both readings were above the consensus estimate of 3.3 percent. That’s pretty strong growth compared to some other countries:

“While U.S. gains have been modest compared with previous expansions, domestic growth is outpacing other advanced economies. Japan’s economy slipped into a recession in the third quarter and the eurozone’s growth barely stayed positive. The rate of growth in emerging markets from China to Brazil is also slowing,” reported The Wall Street Journal.

Although U.S. economic growth during the middle quarters of 2014 was the fastest in a decade, The Wall Street Journal suggested the improvement might be a modest acceleration rather than a major breakout. They cautioned U.S. exports and military spending made attractive contributions to third quarter growth, but that could change if there is a global slowdown or the government cuts military budgets.

What return-on-investment (ROI) does a liberal arts degree deliver? There has been a lot of hullabaloo lately about whether a bachelor’s in English, or any other liberal arts degree, is worth earning. Forbes explained it like this:

“Humanities degrees have received a bad rap recently, even from President Obama. Many people, including top policy makers, routinely push policies to encourage more students to major in STEM fields (science, technology, engineering, and mathematics). Some governors have even suggested that state subsidies for public universities should be focused on STEM disciplines, with less money going to “less useful” degrees such as the humanities. Yet, in contravention to this perceived truth, the data show that humanities degrees are still worth a great deal.”

How much are they worth? While working on a project to estimate the economic impact of his university, Professor Jeffrey Dorfman discovered bachelor’s degrees in art, drama, English, French, history, philosophy, and political science have ROI of 300 to 700 percent for students (or parents) who spent about $80,000 on tuition, room and board, and other education-related expenses. Art majors had the lowest ROI and philosophy majors had the highest.

Make no mistake. There are bachelor’s degrees with higher ROI. The top-paying majors include engineering, mathematics, physics, government, economics, international relations, geology, technology, and chemistry, according to Payscale.com. Classics majors, who earn even more than philosophy majors, came in at number 50 out of 130 majors listed by earnings potential.

Forbes offered some simple guidelines for students who are considering graduate school and want to evaluate whether the investment will pay off. Some suggestions for students are:

·         Assume every dollar of debt will cost two dollars by the time it has been paid back.

·         Estimate the cost impact of years in grad school on potential retirement savings.

·         If undergraduate debt and grad school debt combined are higher than a conservative estimate of first-year salary, then the cost of education is too high.

·         If debt is less than first-year salary, calculate lifetime earnings with and without grad school.

Most importantly, Forbes cautioned, it’s important to remember that all projections could be wrong. A student may not find a job right away or the job found could pay far more than expected. Industries may become obsolete. Economies may falter. It’s difficult to account for all of the variables that may affect income over a lifetime.

Weekly Focus – Think About It

If you recently spent some time circling a mall parking lot, looking for a place to park, you may want to consider an approach recommended to CNBC.com by former math teacher Joseph Pagano. “Rather than circle the lot, idle in an aisle where you can see 10 spaces ahead of you on either side (20 total). Given the average holiday shopping trip duration of 77 minutes, per the Bureau of Labor Statistics, one of those 20 spots should open up in 3.85 minutes or less of waiting.”