The Capital Spectator: Investing, Asset Allocation, and Economic Insights

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        <p>The latest information on durable goods orders suggests that our economy is showing signs of slowdown, if not outright contraction. On a brighter note, initial jobless claims have reported somewhat more favorable figures recently. So, what does this mean for the current economic landscape?<br/>To shed some light, let's examine the data. <a href="http://www.census.gov/indicator/www/m3/adv/index.htm">Durable goods orders</a> decreased by 0.3% last month, marking the third consecutive month of declines. A look at the annual pace of durable goods orders further indicates weakness, as illustrated in our chart below. The downward trend is apparent, continuing on a rolling 12-month basis. Notably, we are increasingly observing negative figures in the annual trend.<br/><small><em>click to enlarge</em></small><br/><a href="https://www.capitalspectator.com/wp-content/uploads/042408a.html" onclick="window.open('https://www.capitalspectator.com/wp-content/uploads/042408a.html','popup','width=617,height=440,scrollbars=no,resizable=no,toolbar=no,directories=no,location=no,menubar=no,status=no,left=0,top=0'); return false"><img fetchpriority="high" decoding="async" src="https://www.capitalspectator.com/wp-content/uploads/042408a-thumb.GIF" width="450" height="320" alt=""/></a><br/>So, how should we interpret the recent filings for unemployment claims? <a href="http://www.dol.gov/opa/media/press/eta/ui/current.htm">The Bureau of Labor Statistics reveals</a> that after peaking at 406,000 claims for the week ending March 29, 2008, new filings have declined to 342,000 as of last week, as depicted in our second chart.<br/><small><em>click to enlarge</em></small><br/><a href="https://www.capitalspectator.com/wp-content/uploads/042408b.html" onclick="window.open('https://www.capitalspectator.com/wp-content/uploads/042408b.html','popup','width=569,height=481,scrollbars=no,resizable=no,toolbar=no,directories=no,location=no,menubar=no,status=no,left=0,top=0'); return false"><img decoding="async" src="https://www.capitalspectator.com/wp-content/uploads/042408b-thumb.GIF" width="450" height="380" alt=""/></a><br/>It's easy to perceive the decrease in new claims as a sign that economic troubles are behind us. However, caution is warranted. One reason for skepticism is that corporations have been managing payrolls more conservatively in recent years, particularly compared to past expansions. Due to outsourcing, advancements in technology, and intense pressure to minimize costs, businesses have not been as eager to expand their workforce as they might have been in decades past. Consequently, this data series may not witness the same absolute surge compared to previous cycles.<br/>Additionally, weekly jobless claims tend to exhibit considerable volatility in the short term. Ultimately, the broader trend serves as a more reliable indicator, and by this measure, it's evident that jobless filings have been rising relatively since last fall. Unless presented with solid reasons to think otherwise, we anticipate continued patterns.<br/>Based on other economic indicators that we monitor, the evidence still points to an economy in distress. For instance, today’s update on new home sales reveals the lowest figures seen in 16 years, as reported in <a href="http://money.cnn.com/2008/04/24/news/economy/new_home_sales_march/">this article.</a> However, recession is not our primary concern at the moment—rather, we are anxious about the future recovery. While everyone knows the pain of recessions, they do eventually pass. That said, we will explore reasons in future posts as to why the forthcoming recovery may not be as robust as in previous cycles. But let’s not get ahead of ourselves; we are currently navigating a downturn, and key questions remain: how long will it last, and how severe will it be?</p>
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        By James Picerno | <a href="https://www.capitalspectator.com/economic-data-du-jour/" title="10:33 am" rel="bookmark"><time class="entry-date" datetime="2008-04-24T10:33:00-04:00">April 24, 2008</time></a> 
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        <p>Have we reached a turning point in the capital markets?<br/>There’s no single measure that can definitively answer this question. In fact, one can only draw conclusions with the passage of time. However, for those seeking insights in real-time, one useful indicator to monitor is the difference between junk bond yields and the 10-year Treasury yield. Recently, this spread has reached a minor milestone, having peaked at 7.93% last month, as seen in our chart below, based on closing yields as of March 17, 2008. The critical question remains: will this peak hold?<br/><small><em>click to enlarge</em></small><br/><a href="https://www.capitalspectator.com/wp-content/uploads/0423081.html" onclick="window.open('https://www.capitalspectator.com/wp-content/uploads/0423081.html','popup','width=592,height=423,scrollbars=no,resizable=no,toolbar=no,directories=no,location=no,menubar=no,status=no,left=0,top=0'); return false"><img decoding="async" src="https://www.capitalspectator.com/wp-content/uploads/042308-thumb.GIF" width="450" height="321" alt=""/></a><br/>Only time will provide clarity. In the meantime, what do recent trends teach us? An investor who purchased junk bonds as an asset class at the peak, specifically on March 17, is currently looking at a 4.5% return, based on the price changes of the <a href="http://finance.yahoo.com/q?s=hyg">iShares iBoxx High Yield ETF (HYG)</a> from that date to last night’s closing figure. Thus far, that performance is average compared to other asset classes. Notably, the S&amp;P 500 has risen by 7.5% during the same period, as per <a href="http://finance.yahoo.com/q?s=spy">the Spider ETF (SPY)</a>, while U.S. bonds have generally regressed by around 80 basis points, measured by <a href="http://finance.yahoo.com/q?s=agg">iShares Lehman Aggregate Bond ETF.</a><br/>Buying when risk premiums are elevated, or selling when they are low, is a strategy that makes logical sense, and over the long run, it may represent the closest thing to a free lunch for strategic investors. Consequently, one might ponder if the 793-basis-point risk spread observed in junk bonds last month served as a buy signal for the long haul.<br/>It’s quite possible. Reviewing spreads since 1999, <a href="https://www.capitalspectator.com/wp-content/uploads/wp-content/uploads/2007/11/the_fed_to_the.html">as we did last November,</a> reveals that a near-800-basis-point risk premium appears appealing, particularly considering that the highest spread over the past nine years was only modestly higher, reaching approximately 1,000 basis points during a brief period in 2002.</p>

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        <p>Investors with experience—often referred to as anyone who has faced losses in the capital markets—rightly harbor skepticism when someone claims to have the secret to successful investing. Such claims seem to emerge every few moments.<br/>This skepticism is underpinned by many factors. Ultimately, the proof lies in the results, and it's no coincidence that there is a significant gap between those who profess to possess insider knowledge and those who can present tangible evidence of success. With this in mind, we recommend approaching the following with a level of caution; your editor proudly counts themselves among those who recognize their own limitations.<br/>This sentiment arises because even a well-informed, thoughtful investment strategy (which we believe characterizes our approach to portfolio design) is fraught with known and unknown risks. The latter category presents the most significant challenges.<br/>As a case in point, consider a known risk, such as avoiding diversification. It is widely acknowledged (or should be) that concentration risk can be avoided easily; thus, those who suffer from it have likely neglected the wealth of financial research documented over the last half-century. This is not to say that diversification should be maintained at all costs; however, one should be fully aware before straying from conventional practices.<br/>Conversely, it is the unknown risks that cause sleepless nights. By nature, these perils are elusive, but we do have some insight into how they emerge. A prime example is the shifting dynamics within the markets, including the interrelationships among various asset classes. It is all too simple to reflect on past trends and draw definitive conclusions about the interaction between capital and commodity markets. However, finance is not a straightforward science, and so previously trusted principles can evolve into something unpredictable.<br/>Two quick examples include: 1) the relationship between the 10-year Treasury yield and commodities; and 2) the remarkable increase in spreads between the overnight <a href="http://www.investopedia.com/terms/i/interbankrate.asp">interbank lending rate</a> and the <a href="http://www.investopedia.com/terms/l/libor.asp">Libor rate.</a></p>

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<div class="entry-content"> <p>The phenomenon known as the Great Moderation, which has been in effect for roughly two decades, raises an essential question: will it continue?<br/>This moderation refers to the significant decline in macroeconomic volatility in the U.S. since the mid-1980s. The fluctuations in GDP have lessened dramatically compared to the turbulent economic landscape of the 1970s and early 1980s. The primary reason behind this change seems to be shorter and milder recessions occurring with less frequency, creating a sense of economic stability. But what has triggered this reduced risk of recession?<br/>Several theories have emerged to explain this phenomenon. One is that the Federal Reserve has gained valuable insights over the decades in managing monetary policy to ensure it is neither overly stimulating nor excessively restrictive. Additionally, the expansion of the service sector, which tends to be less cyclical, has contributed to this stability.<br/>However, do we find ourselves on borrowed time with the Great Moderation? This question is particularly relevant as there are indications that the U.S. economy may already be in a recession, as we’ve previously discussed. Will this downturn prove to be shallow and short-lived as well?</p>

<div class="entry-content"> <p>For five consecutive months, annual consumer price inflation has exceeded 4%, as reported by the <a href="http://stats.bls.gov/news.release/cpi.nr0.htm">Bureau of Labor Statistics</a> today. This marks the first time such a trend has been observed since 1991 (the most recent report noted a 4.0% rise in the CPI over the past 12 months).<br/>Core CPI inflation, which excludes food and energy prices, has remained consistently above 2% annually since September 2004. Recent figures indicate core CPI has risen by 2.4% over the past year. The Federal Reserve typically expresses concern when core inflation exceeds 2% on a consistent basis.<br/>It appears that inflation has escalated to a new plateau, making a return to lower levels increasingly unlikely. While it is important to note that a headline inflation rate of 4% and core inflation around 2% is hardly apocalyptic, we are still far from the inflationary troubles witnessed during the 1970s.<br/>Nevertheless, inflation has increased to a level that is likely to persist unless tighter monetary policy is implemented. It's worth noting that while the Fed may not immediately begin raising interest rates, it seems that the era of rate cuts is nearly over. Leaving the federal funds rate at 2.25% while headline inflation exceeds 4% appears to be a precarious situation.<br/>It's important to recognize that history indicates that inflation tends to rise gradually, almost imperceptibly. No announcement will proclaim the onset of a new inflationary era at a specific moment. Instead, the transition from controlled inflation to more pronounced pressures unfolds slowly and incrementally. Only in retrospect does it become clear that pricing pressures have increased significantly.<br/>In 2008, many hope that a slowing economy will alleviate inflationary pressures. While this is a possibility, history suggests that relying on macroeconomic shifts for managing inflation typically yields disappointing results. Perhaps this time will be different, but current data suggests that adopting a wait-and-see approach may become increasingly risky when it comes to monetary policy. For now, that remains the Fed's course of action, but for how long will that be the case?</p> </div> <footer class="entry-meta"> By James Picerno | <a href="https://www.capitalspectator.com/still-waiting-still-hoping/" title="9:05 am" rel="bookmark"><time class="entry-date" datetime="2008-04-16T09:05:30-04:00">April 16, 2008</time></a> </footer> </div>

<div class="entry-content"> <p>The latest update on wholesale prices reveals an unsettling 1.1% increase over the past month. Nonetheless, <a href="http://www.cbot.com/cbot/pub/page/0,3181,1563,00.html">the Fed funds futures market</a> still anticipates another rate cut when the Federal Open Market Committee convenes on April 29 and 30.<br/>While another rate cut may be on the table, the time for drastic reductions of 75 basis points in the Fed funds rate has passed. The opportunity to curtail inflation momentum has become pressing. Today's producer price report indicates that the central bank needs to prioritize rising pricing pressures. While the Fed may be limited in its ability to stimulate the economy through broad interest rate changes, it can still play a crucial role as a guardian against inflation.</p>

<div class="entry-content"> <p>In a welcome twist, <a href="http://www.census.gov/marts/www/marts_current.html">retail sales increased by 0.2% last month,</a> reversing February's decline and offering a glimmer of hope to the dwindling number of optimists who believe in the resilience of economic growth. However, while financial markets may react enthusiastically to this news, the overarching trend in retail sales cannot be overlooked.<br/>As our chart below illustrates, the cycle of consumer spending remains clear: it is on a downward trajectory. Over the past year through March 2008, advance estimates of U.S. retail and food services sales increased by only 2.3%, reflecting one of the slowest annual growth rates since the previous downturn between 2001 and 2003.<br/><img loading="lazy" decoding="async" alt="041408a.GIF" src="https://www.capitalspectator.com/wp-content/uploads/041408a.GIF" width="455" height="372"/><br/>Furthermore, aside from the positive indication of last month’s performance, the rise in retail sales appears modest compared to historical data. In fact, the 0.2% gain in March (or 0.15% if calculated to two decimal places) pales in comparison to past monthly increases, as highlighted in our second chart below.<br/><img loading="lazy" decoding="async" alt="041408b.GIF" src="https://www.capitalspectator.com/wp-content/uploads/041408b.GIF" width="457" height="372"/><br/>Consequently, while monthly data may present anomalies and yield seemingly large increases, these fluctuations do not negate the reality that the economy is slowing and likely headed for a contraction at least temporarily this year. This isn't an apocalyptic narrative, nor is the downturn expected to extend beyond what is considered normal. However, uncertainty remains, and the guessing game continues.</p>

<div class="entry-content"> <p>Today's import price update presents yet another concerning view of rising pricing pressures.<br/>According to the U.S. Labor Department, import prices surged by 2.8% last month. This is the largest increase since last December's alarming 3.2% rise. Even more concerning is that the 2.8% increase in March stands at the upper range of monthly fluctuations dating back to the 1980s. Compounding the worry, import prices have escalated by 14.8% when measured over the past year, as shown in our chart below. This marks the highest annual increase since the Labor Department began recording such data in 1982.<br/><img loading="lazy" decoding="async" src="https://www.capitalspectator.com/wp-content/uploads/041108.GIF" width="469" height="373"/><br/>The only silver lining is that much of the rise in import prices can be attributed to escalating energy costs, and one can reasonably hope that such prices won't continue to rise indefinitely. Nevertheless, stripping energy from the equation reveals a 5.4% rise in non-petroleum import prices over the past year. While this smaller increase may seem reassuring, it is, in fact, the highest annual pace recorded since the 1980s. Overall, the declining trend remains evident, regardless of how one analyzes import prices.<br/>How concerning is a 5.4% rise in non-petroleum imports? To answer that, consider that overall inflation in the U.S. is climbing at 4% according to the annual consumer price increase through February. Moreover, the nominal growth rate of the economy during the fourth quarter of 2007 was 3%. In summary:<br/>* Non-petroleum import prices are rising at a rate approximately 33% faster than general inflation.<br/>* Non-petroleum import prices are growing 80% faster than the nominal GDP growth rate.<br/>Adding energy costs back into the equation renders the situation, well, significantly worse.</p>

<div class="entry-content"> <p>The International Monetary Fund (IMF) reported yesterday that global economic growth is decelerating in its latest <a href="http://www.imf.org/external/pubs/ft/weo/2008/01/index.htm">World Economic Outlook (WEO).</a><br/>The report states that, “the global expansion is losing momentum in light of a significant financial crisis,” with the U.S. being pinpointed as the leading cause due to the downturn in the housing market. “Emerging and developing economies have experienced less shock from financial market turbulence and continue to grow rapidly, with China and India at the forefront, although growth is beginning to moderate in some regions.”</p>

<div class="entry-content"> <p>In today's investment landscape, gaining exposure to various asset classes is straightforward, thanks to the abundance of ETFs and mutual funds that cater to virtually every major and niche category in financial and commodity markets. Nevertheless, the critical questions persist: what is Mr. Market offering, and how does his historical performance measure up?<br/>These inquiries are vital for strategic investors aiming to understand the true global market landscape, which by its nature entails comprehensive diversification. Unfortunately, we haven’t encountered an off-the-shelf index that encapsulates the global portfolio. To address this gap, your editor has created the Capital Spectator Global Market Portfolio Index (GMP), which serves as an approximation of global capital and commodity markets, weighted according to Mr. Market’s valuation. This index will be referenced in upcoming posts to draw comparisons and analyze different market trends.<br/>As for the performance of the GMP, the brief answer lies in the chart below, which displays the total return performance of GMP relative to the S&P 500. As seen, GMP has consistently outperformed the S&P 500 from the end of 2001 through March 31, 2008.<br/><small><em>click to enlarge</em></small><br/><a href="https://www.capitalspectator.com/wp-content/uploads/040808.html" onclick="window.open('https://www.capitalspectator.com/wp-content/uploads/040808.html','popup','width=568,height=443,scrollbars=no,resizable=no,toolbar=no,directories=no,location=no,menubar=no,status=no,left=0,top=0'); return false"><img loading="lazy" decoding="async" src="https://www.capitalspectator.com/wp-content/uploads/040808-thumb.GIF" width="450" height="350" alt=""/></a><br/>Upon reviewing the trailing performance figures, the GMP index has yielded a 13.4% annualized total return over the five years leading up to the end of last month, compared to 11.3% for the S&P 500. Furthermore, the GMP index achieved this superior performance while maintaining approximately three-quarters of the S&P's volatility over that same period (quantified by the annualized standard deviation of monthly total returns). The tangible benefits of this smoother path become evident especially in recent times. From the peak of the S&P in October 2007, the stock market has faced a decline of -13.8% through the end of last month, whereas GMP experienced only a slight -3.2% loss.</p>

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