In recent months, we have observed that the recession seems to be approaching its “technical” conclusion. However, the recovery will likely be slow, fragile, and extended over an unusual timeframe. Two recent news stories underscore this ongoing analysis, illustrating our points more effectively than we could convey ourselves.
This morning’s report on retail sales adds weight to the idea that the economy may be stabilizing, and possibly even on the verge of modest growth. The 2.7% rise in seasonally adjusted retail sales for August marks the highest increase since January 2006.
Furthermore, a deeper analysis of the report reveals that the gains were widespread, with only furniture/home furnishing stores and building materials/garden equipment outlets reporting lower sales for the month, seasonally adjusted.
However, we must exercise caution in interpreting these numbers. It’s essential to remember that vehicle sales significantly drove consumption higher in August, with the government’s cash-for-clunkers program playing a notable role. Yet, this automotive phase of the fiscal stimulus appears to be at an end for the time being.
Since the U.S. stock market peaked in October 2007, it has been a winding journey. While countless details of this period have been scrutinized, it’s vital to zoom out and consider the overall performance of major asset classes during this time.
We can analyze total return indices for key asset classes, setting a benchmark of 100 at the close of October 2007. The chart below highlights asset class performance up to the end of August 2009. (For the underlying indices representing asset classes, refer to our post here.)
Our second chart also provides a perspective on the same data, ranking total returns from October 2007 through August 2009.
At The Beta Investment Report, we continually analyze major asset classes with the primary goal of gaining insights into managing multi-asset portfolios while achieving better returns without additional risk. This process involves assessing rebalancing opportunities based on performance comparisons. So far, it appears that foreign government bonds may warrant some trimming, while investing in REITs seems promising relative to results from October 2007 through last month.
This morning’s update on initial jobless claims provides further evidence to suggest that the economic downturn may have reached its nadir. However, this doesn’t mean we can declare a genuine recovery just yet, as we’ve emphasized over the past several months, including in this and this discussion. Nonetheless, the consistent decline in initial jobless claims—a critical leading indicator of the business cycle—continues to suggest that the global recession is concluding or has nearly concluded.
While it might not be the traditional canary in the coal mine, it certainly feels like one. When even Joe Sixpack’s once carefree spending behavior shows signs of restraint, it’s clear that something has shifted. This is evidenced by the downturn in gambling revenues from casinos and lotteries, marking a first according toThe New York Times.
“The decline in gambling comes amid states rapidly expanding this form of entertainment to tackle significant budget deficits, clearly indicating that gambling is not immune to the broader economic challenges posed by recessions,” the article states.
Reported declines include: Illinois, which noted a drop of $166 million in fiscal year 2009 compared to the previous year; Nevada, seeing a $122 million decrease; and New Jersey, reporting a $62 million shortfall.
Is nothing sacred in the Great Recession’s overhaul of spending priorities? Apparently not, except perhaps in the consistent spending tendencies of Washington and certain personal services in red-light districts. For average consumers, however, the game has changed, and they are no longer heading to Vegas or its peers. If the crowds don’t return, it will be challenging to sell an extra load of widescreen TVs next week.
The market has been experiencing considerable turbulence lately, and it’s not just in investment returns. The notion that market prices convey valuable information seems to be under scrutiny once again.
Paul Krugman’s recent article in the New York Times Magazine, titled “How Did Economists Get It So Wrong?” is part of this critique. Among the many allegations, it’s claimed that the efficient market hypothesis (EMH) has contributed to the economic problems currently facing the U.S.
The critique of EMH has become increasingly popular, and while some of these critiques hold merit, others are exaggerated or flat out incorrect, particularly regarding their application to investing. We’ve discussed these issues extensively and will delve deeper into this in our upcoming book,Dynamic Asset Allocation: Modern Portfolio Theory Updated For The Smart Investor, set to be published in February by Bloomberg Press. For now, let’s focus on one aspect of Krugman’s story regarding economic management.
Conditions seem to be improving, or at least the pain is becoming less intense. Nevertheless, the labor market cannot be classified as healthy at this juncture, nor is it clear when true recovery will occur.
The nonfarm payrolls experienced another drop last month, yet the positive news is that the loss of 216,000 jobs in August represents the smallest decline of the year and is significantly lower than July’s revised figure of 276,000, as reported by the government today.
This suggests that August is a step in the right direction. Trends have certainly improved compared to the average loss of 648,000 jobs in the first four months of this year.
Despite this, our previously noted economic outlook remains unchanged. On one hand, the technical conclusion of the recession seems imminent, if it hasn’t already occurred. This suggests that the upcoming third-quarter GDP estimate could reveal modest growth when the government releases its first estimate on October 29. However, even if economic growth resumes, it will likely be accompanied by a weak labor market.
August marked another impressive month for REITs, with no competition from other major asset classes.
The Wilshire REIT index surged in August, delivering a total return of 14.6%, following a gain of over 10% in July. However, for the year, REITs achieved a robust return of 10%, though not enough to place them at the top of the rankings.
It wasn’t long ago that many were predicting a poor outlook for REITs. However, predictions often fluctuate: in the grand scheme of things, forecasts can be as frequently wrong as they are right. For this reason, it remains difficult to outperform a true market portfolio, such as our Global Market Portfolio Index. While a few investors may achieve success, many fall short compared to what financial theory indicates is the optimal portfolio for a long-term investor.
Returning to the rankings, the bottom of last month’s asset class performance table included emerging market stocks and commodities, both of which recorded slight losses in August. However, for the year thus far, the returns from emerging market stocks have soared over 48%, contrasting sharply with commodities’ more modest gains of 7.4% through the end of last month.
Interestingly, a broader range of returns among significant asset classes appears set to continue, signaling a return to historical norms, as discussed in the forthcoming September issue of The Beta Investment Report. The recent high correlations among global capital and commodity markets seem to be dissipating, suggesting that investors managing multi-asset portfolios will have more opportunities but also increased risk as returns become more variable—both positively and negatively—in the upcoming months and years.
The landscape of investment is shifting, as it always does, offering both new opportunities and risks. The days of universally rising asset prices may be behind us. Whether the market is ready for this change remains open to debate.
In conclusion, vive la différence!
It is fitting that Sweden’s Riksbank, the world’s first central bank, has made history by lowering one of its key interest rates to negative 0.25% since July 8.
This move marks a groundbreaking shift in monetary policy, suggesting that the zero lower bound may not be a limitation that central banks cannot overcome. In 2004, Fed Chairman Ben Bernanke, then a Fed governor, co-authored a research paper indicating that “the nominal policy interest rate may become constrained by the zero lower bound.”
Clearly, that notion has been contested, as the Riksbank managed to set rates below zero with relative ease. While Sweden’s -0.25% deposit rate (the rate banks receive for funds held at the central bank) is not the principal instrument of monetary policy—reserved for the repo rate, which remains stable at 0.25%—it does set a new precedent in central banking. The move to negative rates has occurred in the modern banking landscape, and the financial world is adapting.
According to the recent data on personal consumption expenditures, there was a 0.25% increase last month—potentially a positive sign since it represents the third consecutive month of modest gains. This suggests that consumers may be beginning to restore their capability and willingness to spend. However, this perception may be misleading.
Government stimulus initiatives, particularly the cash-for-clunkers program—where the government subsidizes vehicle purchases—remain critical to supporting consumer spending. As an economist noted in Bloomberg News, “While the cash-for-clunkers program bolstered auto sales, it adversely affected other sales, highlighting that overall consumption remains weak. Consumers are hesitant to spend in other areas and face limitations, primarily because income growth continues to be sluggish,” explained Christopher Low, chief economist at FTN Financial.
Additionally, disposable personal income has continued to wane, though only slightly in July compared to a 1.1% drop in June. “The fiscal stimulus that boosted disposable incomes in the spring is now diminishing,” noted Paul Dales, an economist at Capital Economics, in a report for clients via the Christian Science Monitor. “Excluding the fiscal boost, incomes have been trending downward for the past seven months.”
Addressing this trend will ultimately hinge on a rebound in the labor market. So far, the only positive indication on this front is that job losses are slowing. While this is encouraging, it is vital to recognize that it is only a relative improvement compared to the rapid job loss experienced previously.
Overall, today’s update on personal income and spending does not alter our fundamental perspective: while the “technical” end of the recession may be here or on the horizon, it will likely be succeeded by a prolonged period of anemic growth.
Learning to navigate a landscape of minimal growth is the new challenge that lies ahead, and the process of adjustment has only just begun.
