Recent reports on unemployment benefit applications bolster the idea that the economy is on a gradual path to recovery. While this recovery is fragile and accompanied by significant uncertainties, the data nonetheless implies a positive trend.
The Labor Department has announced that initial jobless claims fell to 502,000 last week, down from 514,000 the previous week. This marks the lowest figure since the week ending January 3, 2009. As illustrated in the chart below, the trend in jobless claims has shown an encouraging downward movement this year.
Earlier this year, in March, we discussed the possibility that a peak in jobless claims could indicate the end of the recession. In subsequent months, we have revisited compelling evidence showing that initial claims have followed a sustainable downward trend, as seen here and here. Although jobless claims alone do not serve as definitive indicators of future economic conditions, this data is critical for identifying potential turning points in the business cycle.
The world offers a plethora of recommendations and research on effective strategies for financial management. However, when distilled to their essence, two fundamental rules emerge: first, diversify within and across asset classes (asset allocation) and second, regularly rebalance your portfolio.
While other principles exist and can be beneficial, these two rules form the foundation of sound investment strategy for most individual and many institutional investors. Ignoring these guidelines can significantly hinder investment success.
Of course, it’s feasible to contravene these rules and still achieve substantial returns. However, this path typically requires one to be exceptionally astute or inclined to undertake risks that could derail most investors. For the majority, adhering to asset allocation and rebalancing principles is essential for prudent investing. While intelligent investing can extend beyond these basics, they certainly represent a solid starting point.
A strong contributing factor to the recent market rally is the realization that inflation is not currently a pressing concern. The financial crisis of last year significantly dampened the tendency of fiat currencies to lose purchasing power over time. Consequently, we find ourselves with an unusual degree of economic leverage to maintain historically low interest rates.
In fact, the primary objective of the Federal Reserve and central banks globally over the past year has been to stimulate inflation—though not necessarily achieve high inflation levels.
During the heart of the crisis, the immediate goal was simply to generate some level of inflation, aiming to avert the dangers of deflation, which poses a severe threat. The fundamental strategy has been to inject liquidity into the economy through money printing. How effective has this strategy been?
Today’s employment report for October brings neither shock nor encouragement. The U.S. economy continues to lose jobs at an alarming rate, which comes as no surprise given recent trends, highlighting the risk of a jobless recovery.
Nonfarm payrolls decreased by another 190,000 positions last month, a slightly reduced rate compared to September’s 219,000 loss, yet still far from suggesting stabilization in the labor market. Job losses were primarily concentrated in goods-producing sectors, while the services sector also experienced a decrease of 61,000 jobs. However, education and health services managed to add 45,000 jobs, along with professional and business services increasing by 18,000. Despite these minimal gains, today’s employment report offers little more than the optimistic note that the rate of decline is significantly lower than during the peak of the financial crisis late last year and early 2009. This highlights the ongoing challenge after nearly two years of labor market contraction.
The silver lining is that the elusive point of zero job loss is approaching, possibly within the next few months. Optimistically, this could happen by year-end, although a more realistic estimate may be the first quarter of next year. Absent major disruptions to the current economic landscape, stability in the labor market appears imminent. The greater challenge, however, lies not only in halting job losses but also in generating new employment opportunities.
Sometimes a single statement encapsulates everything, as shown by Jim O’Neill’s remark about the significant challenges central bankers face worldwide. The timing of an upward shift in interest rates remains uncertain. Meanwhile, the economy is riddled with various risks.
The chief global economist at Goldman Sachs, recently highlighted in an interview that “there are all kinds of risks” arising from the intersection of monetary policy, inflation, economic cycles, and other variables. Several central banks have already begun raising rates, albeit modestly. As markets contemplate the future, ongoing debate surrounds whether the reflation seen recently is the result of deliberate actions or a genuine improvement in economic conditions—perhaps it’s a blend of both. Regardless, Mr. O’Neill succinctly expressed a palpable uncertainty when he asserted, “We don’t know how much of the improvement in markets is due to central banks’ largesse, and neither do they. They’re pretty nervous, but they’ve got to get out of it at some stage.”
The first principle of investing recognizes that there are no guaranteed solutions. Asset pricing remains a complex puzzle. While the last fifty years of financial analysis have illuminated some aspects, a significant amount still eludes our understanding.
Most of what we comprehend stems from reverse-engineering market data. We have access to prices, and we can track their fluctuations and interrelations in numerous ways. However, the underlying code that produces these outputs has not been provided to us, leaving us tasked with predicting returns through indirect methods. Even then, we operate with incomplete information. Our reality is dominated by historical data; we know the past, yet this offers little insight into the future. While we have access to outcomes, our debates often center around the inputs. This results in a tenuous relationship between historical and forward-looking data. Although the historical record shouldn’t be disregarded, it should merely serve as one of several layers of analysis when establishing capital market assumptions.
Much of the discussion on The Beta Investment Report revolves around cultivating equilibrium risk premiums and melding long-term forecasts with immediate insights. If a significant divergence arises and we possess reasonable confidence in our assumptions, we can justify adjustment of the asset allocation for our market portfolio, broadly defined as per finance theory. This encompasses a global value-weighted mix of stocks, bonds, commodities, and REITs, also known as our proprietary Global Market Index.
A month ago, we evaluated the latest performance metrics for major asset classes and pondered how long the upward trend could persist. A month later, we have our answer. As illustrated in the table below, the divergence in results within capital and commodity markets has returned.
The shift to varied performance was unavoidable. We have previously noted that the remarkable recovery period of 2009 was likely to be brief. When it became evident earlier this year that the world would not collapse, asset prices were adjusted accordingly. However, the first indicators that performance trends would not remain uniform were present in last month’s asset class results.
Today’s report on income and spending for September tarnishes the optimism from yesterday’s favorable GDP announcement. A closer examination of the third quarter reveals its impact on consumer sentiment, compounded by persistent challenges in the labor market. The upward trend that fueled August’s optimism, contributing to a strong Q3 GDP, has reversed in the final month of the quarter. There are concerns that negative sentiment could persist into the last months of the year.
The government has reported a 0.1% decline in real disposable personal income for last month, while personal consumption expenditures dropped by 0.6%. Our previous analysis indicated that while the Q3 GDP figures were promising, a battle for growth lies ahead—a sentiment that today’s figures reinforce.
Notably, government payments were the sole positive contributor to employee compensation in September. This could explain the dwindling momentum in consumer spending as the impact of government stimulus programs diminishes. Although consumer spending is not necessarily on a persistent downturn, it is equally unrealistic to expect a quick recovery to levels seen over the past year.
It is now confirmed: the U.S. economy expanded by 3.5% in the third quarter, according to today’s report from the Bureau of Economic Analysis release. While this is certainly encouraging, it neither comes as a surprise nor signals the resolution of the financial turmoil experienced over the past year. Nevertheless, it is a step in the right direction, albeit a cautious one that does not guarantee future acceleration.
Nevertheless, any good news should be acknowledged and celebrated. After four successive quarters of contraction, a GDP increase marks a significant shift. Moreover, a deeper dive into the figures shows that the expansion was widespread, with all major components contributing positively during Q3. Notably, personal consumption expenditures, gross private domestic investment, exports, and government spending all saw increases during the three months ending in September—contrasting with the negative trends observed in previous quarters, save for slight increases in government spending and consumer expenditures in Q1 2009.
Today’s update on new orders for durable goods highlights that the drastic effects of the Great Recession have subsided, yielding to the more gradual process of rebuilding.
The news remains generally positive, as the immediate fears associated with the recent past diminish. Thus, the crowd can view the 1.0% growth in new durable goods orders with renewed optimism. As shown in the chart below, orders are gradually rising from the low levels witnessed in the first half of this year. However, it’s clear that the recovery process will require time and patience due to the usual challenges faced in the aftermath of any economic downturn. This applies not just to durable goods, but to various indicators of economic activity as well.
Nonetheless, we should celebrate the good news, even if briefly. Orders have risen at a commendable pace, even after filtering out the usual volatility in transportation and defense. This suggests that the uptick is broadly based, with only a few exceptions.
### Conclusion
In examining recent economic indicators, we observe both promising signs and persistent challenges. From falling jobless claims to cautious GDP growth, the data suggests a complex landscape where positive trends battle against underlying weaknesses. Continued attention to these details will be essential for navigating the path to sustainable recovery.
