Though it’s not entirely over, the end seems to be nearing. In March, we took a detailed look at initial jobless claims as a potential predictor of economic recovery. We pondered whether this critical data series would maintain its historical accuracy in signaling the conclusion of the recession. While real-time answers remain uncertain, recent data certainly fuels optimism.
Last week, new jobless benefit applications fell to 601,000 — the lowest figure since late January, as reported by the Labor Department yesterday. Given the past 40 years of trends, there are still reasons to believe the recession’s official end is either here or on the horizon.
Additionally, corroborating evidence surfaced with yesterday’s retail sales report, which indicated a seasonally adjusted increase of 0.5% for May — the first monthly rise since February. This is encouraging, especially since the gains were quite widespread, although some exceptions exist. Nevertheless, there’s a reason we describe the potential end of the recession as “technical.”
Arthur Laffer warns in today’s Wall Street Journal that we should “Get Ready for Inflation and Higher Interest Rates.” The market has been signaling this for some time. Although concerns about deflation have taken center stage since the financial crisis began last fall, the real challenge lies ahead — once the Federal Reserve successfully dispels the dangers of deflation.
A review of recent changes to the market’s inflation expectations reinforces the belief that the economic future will not mirror the past. Our charts, such as this one and that one, clearly show a trend: pricing power is re-emerging. While it is undoubtedly starting from an exceptionally low baseline, this resurgence is significant. The central bank is employing potent strategies to revive inflation from stagnation, and we remain confident that Ben Bernanke and his team will achieve success.
The world recently lost an influential financial historian and analyst, Peter L. Bernstein, who passed away in New York on Friday.
As an accomplished author and investment strategist, Bernstein created an analytical framework that has become common in blogs, mainstream media, and beyond: interpreting academic literature for a broader audience.
While he wasn’t the only one to make complex financial theories accessible, few did it with the same skill and depth that Bernstein exhibited. When he published his seminal work “Capital Ideas: The Improbable Origins of Modern Wall Street
In early March, we posed the question: When Will It End? At that point, we suggested observing the weekly fluctuations in new jobless claims as a useful strategy for predicting when the economic cycle might shift.
Historically, initial jobless claims tend to peak either concurrently with or just ahead of the recession’s technical end, as determined by the National Bureau of Economic Research. Waiting for the NBER to declare the end of a downturn is not practical, given their typically lengthy deliberations. Hence, monitoring initial jobless claims can provide a timely insight into what may come next for the economy. They should not be analyzed in isolation; rather, they must be considered as part of a broader review of leading economic indicators, making them valuable for forecasting the future.
Today’s jobs report, which accompanies yesterday’s update on jobless claims, offers more data to support the validity of our March assessment. While jobs were still lost last month, the decrease was significantly milder compared to previous months. According to the Labor Department reports, nonfarm payroll employment fell by 345,000 in May — around half the average monthly decline over the previous six months.
While inflation isn’t currently a concern, deflation appears to be less of a worry as well. We’re not yet ready to assert that the risks associated with deflation have completely disappeared, but we are getting close. And we’re not alone in this impression.
The bond market seems increasingly prepared to move past concerns about a deflationary spiral. However, this doesn’t imply that inflation is returning. There is no simple switch to flip that transitions from one state to the other as easily as turning on a light.
The economic ebb and flow serves as a gradual process. Currently, it seems we are moving from a state of heightened deflation risk to one where such risk is absent, which should not be equated with the immediate onset of inflation. There’s no guarantee that inflation must quickly follow deflation — the eventuality will largely depend on the actions of the central bank in the months and years to come.
The latest figures on personal income and spending deserve our close attention. The details, coupled with the government’s stimulus efforts, provide crucial insights.
First, the positive news: disposable personal income increased by a strong 1.1% in April, according to the Bureau of Economic Analysis report. This kind of growth is typically seen during robust economic expansions. So what is it doing amid one of the worst recessions since the 1930s?
The government has indeed learned valuable lessons about Keynesian economics since FDR’s era. While Washington has become adept at delivering immediate financial assistance, it still struggles to motivate consumers to spend those stimulus funds. Could a mandatory spending bill be the answer? Perhaps transferring funds directly to retailers instead of consumers might help. In fact, some measures in that direction are already being implemented, as large corporations that should have faltered continue to operate, supported by government aid.
Despite being labeled as the worst recession since the 1930s, remarkable bullish trends have emerged within capital and commodity markets. This economic backdrop likely fuels bouts of aggressive buying.
However, caution is warranted in light of these rapid gains. While the past several months have been thrilling, reminiscent of the 2003-2007 era when the market was thriving, we must remember that the current gains are primarily driven by a renewed sense of optimism that the world isn’t doomed.
Investors may soon seek more conventional reasons, such as earnings growth and sustainability plans, rather than relying solely on survival as a catalyst for investment.
May marked a thriving period for markets globally, with nearly everything experiencing upward movement. Emerging market stocks and commodities led this charge.
Despite these successes, significant losses from late 2008 remain evident, affecting all but developed-world bonds on an annual basis. The extensive rebounds over the past three months were practically expected after the steep declines leading into spring 2009. However, as we reflect on this rebound, we must consider: what lies ahead?
The recent surge can be perceived as a correction of overexaggerated fear-based pricing; the global economy now seems stable, and markets have responded accordingly. However, the simplistic all-or-nothing outlook is evolving into a more nuanced understanding of economics. We are entering an era of post-crisis pricing, yet no one is entirely clear about the new pricing dynamics, as guidelines for future market behavior are still under discussion.
Valuing assets based on anticipated developments will become increasingly challenging. While we show signs of resilience, the specific shape of our recovery remains to be defined. How to appropriately gauge the new economic landscape will require careful consideration and insight from policymakers as the situation unfolds.
What can we expect from Mr. Market? The answer remains uncertain, but proactive investors should evaluate the numbers meticulously.
The importance of scrutinizing investment assumptions cannot be overstated. By continually assigning an expected price to risk, we enhance our investment acumen. Though crystal balls do not exist, improving our ability to forecast the future could serve as a valuable tool for better returns.
In an upcoming issue of The Beta Investment Report, we project a market portfolio risk premium of 2.5%. This estimate is derived from aggregating forecasts for major asset classes according to their market-cap distribution within the overall portfolio. Overall, our projection takes on a long-term perspective based on equilibrium assumptions, and we believe it serves as a reasonable benchmark. However, we must remain cautious and stress test our assumptions continuously. Here’s a brief overview of the core concepts, demonstrating the nuanced dynamics that keep us speculating about the future.
Is this an ominous signal, or merely a step toward normalcy?
For now, the jury is still out, but it’s evident that the yield on the benchmark 10-year Treasury Note is on the rise. Yesterday’s increase to 3.71% marked its highest level since last November. What does this signify?
One perspective is that the yield is returning toward normal levels. As fears of economic meltdown fade, the price of borrowing is expected to approach the ranges we saw before the financial turmoil of late 2008. This suggests a yield between 3.5% and 4.0% for the 10-year note, a range common during much of the previous summer.
However, in the current economic climate, things are rarely straightforward. Remember, it was just in March that the Federal Reserve announced its plans to purchase long-term government bonds to keep rates low as part of its economic recovery strategy. Following that announcement, the yield on the 10-year note plummeted by 50 basis points in one session, settling around 2.5% on March 18. As of last night, the yield stood 120 basis points higher. What does this indicate about the Fed’s commitment to maintaining low rates?
Seventeen years have passed since professors Eugene Fama and Ken French published a groundbreaking paper that recognized small-cap value as a separate equity beta deserving special attention. The central premise is that stocks overlooked by the broader market, indicated by low price-to-book ratios, carry more risk than the market average. Investors willing to navigate this risk are rewarded with superior long-term returns.
Multiple theories explain why small-cap value stocks yield higher returns than conventional interpretations of modern portfolio theory suggest. One possible explanation is that small-cap value acts as a proxy for the risk associated with business cycles. These stocks tend to be more vulnerable during recessions, leading investors to avoid them. This avoidance creates an elevated expected return for small-cap value shares.
