This past spring saw the yield on the 10-year Treasury Note rise to nearly 4.0% by mid-June, but recently it has paused. This upward trend has led some to suggest that the underlying cause—concerns regarding future inflation—may have been exaggerated.
While we acknowledge this perspective, we maintain a different view. Even amidst the turmoil of last fall’s crisis, we anticipated that inflation would reemerge at some point. The recent CPI report supports this ongoing belief.
It’s important to note that concerns about an immediate surge in inflation remain low. Although deflationary pressures are subsiding, the aftershocks of the financial crisis and the ongoing recession will linger for a while, meaning pricing pressures are still relatively subdued. Nevertheless, it has always been clear that the Federal Reserve’s main objective is to tilt the economy back toward an inflationary bias—ideally a moderate one, but inflationary nonetheless. We have always believed in the Fed’s ability to achieve this, a sentiment echoed by the bond market. The real question is whether the central bank can carefully release the constraints without causing chaos.
After much anticipation, my upcoming book, Dynamic Asset Allocation: Modern Portfolio Theory Updated for the Smart Investor (Bloomberg Press), is now available for pre-order on Amazon.com. The release is scheduled for February 2010.
In the coming weeks and months, we’ll delve deeper into the book’s contents. Meanwhile, for more information on how to purchase a copy, click on the link below…
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We’ve experienced disappointments before; could this time be different?
Eventually, the recession will end, and we will hit a low point for the economy. Are we close? This week gave us several reasons to cautiously respond with “yes,” or perhaps “maybe.”
Recent news provides another glimmer of hope: both new housing starts and new building permits showed an increase last month, as reported by the U.S. Census Bureau today. For the second month in a row, both data sets showed respectable improvements.
Aside from Wednesday’s report indicating a continued decline in industrial production, this week generally leaned towards the belief that we might be nearing—or perhaps have already reached—a trough in the business cycle.
Each update on jobless claims provides another reason for cautious optimism.
This week, the Labor Department reported a drop of 47,000 in initial jobless claims for the week ending July 11, totaling 522,000—the lowest figure since early January. This decline is particularly promising as it indicates that the significant drop observed during the holiday week through July 4 was not a one-time anomaly.
Since March, we’ve highlighted that initial jobless claims have historically peaked just before or around the conclusion of recessions (for further insights, see here and here). However, we’ve also been cautious in noting that the current situation might prove to be a bit distinct in terms of its implications for the near future.
While deflation continues to be a concern, this wasn’t reflected in today’s consumer price update for June.
The CPI rose by 0.7% last month, according to the government report. This marks the highest increase since July 2008, which also saw a 0.7% rise.
Much of this CPI gain was driven by energy prices; however, core CPI (which excludes food and energy) still saw a 0.2% increase. Year-to-date, core CPI has recorded monthly gains consistently. Additionally, the annualized three-month core CPI rate through June stands at 2.4%, exceeding the Federal Reserve’s long-term target for core inflation. Interestingly, even though overall consumer prices have declined by 1.4% based on the headline CPI, core inflation has risen by 1.7%.
What can we infer from this? While inflation still appears subdued, it is not completely absent from our medium- to long-term outlook. The current report does not forecast an imminent inflation threat, as ongoing deflationary pressures should keep overall prices stable for the foreseeable future. Nonetheless, today’s CPI data indicates that the potential for inflation risks remains present.
This week’s economic reports have started strong with updates on retail sales and wholesale prices for June.
The seasonally adjusted retail sales rose 0.6% last month, according to the U.S. Census Bureau report. This marks the highest monthly increase since January.
The wholesale price report for June also signals positive outcomes, with the Producer Price Index (PPI) increasing by a seasonally adjusted 1.8%, as stated by the Bureau of Labor Statistics report. Although much of this rise stemmed from a recovery in energy prices, even when excluding fuel, a notable increase of 0.5% in core PPI was observed. Overall, the headline PPI has risen for three consecutive months.
While these numbers don’t provide a definitive all-clear signal, they are nonetheless encouraging. One positive takeaway is that the figures could have been significantly worse. As we have discussed previously, the first step in stabilizing the economy involves effectively eliminating the risk of deflation. We may soon be able to proclaim success in that area. Perhaps it is time to declare as much now. In any case, progress is being made—evidenced by the apparent peak in new jobless claims that we have noted over the past several months.
Nevertheless, we remain skeptical about meaningful growth coming anytime soon. Despite the latest retail sales figures, consumer spending is likely to remain weak for some time, given that the labor market is still shedding jobs at a concerning rate. Repairing this trend will take time, and meanwhile, consumer spending will continue to suffer. However, at least it no longer appears to be in freefall—a crucial consideration for an economy that depends on consumer spending for around 70% of its GDP.
Every economic report seems to reveal essential insights for understanding the future, and this week is no exception.
The critical question now is whether the stability we’ve experienced in recent months is at risk of being undermined, potentially sending the economy back toward contraction. It’s tempting to think we’ve moved beyond that phase in spring due to some positive data, suggesting that while growth may be a ways off, the recession has stopped worsening.
However, following the June payrolls report, which presented unexpected negative findings, there’s renewed speculation about additional challenges ahead. In such circumstances, should we anticipate another round of stimulus? Several key economic indicators set to be released this week will provide crucial insights.
Meanwhile, Warren Buffett suggests that it may be time to re-initiate stimulus efforts. Yet, not everyone shares this sentiment, at least not yet.
Forecasting economic trends is notoriously difficult, especially as they pertain to the future.
Currently, a pressing question is whether the so-called green shoots of recovery are beginning to wither. It’s becoming increasingly hard to confidently say “no.” While it remains uncertain whether we’ll face a second economic setback, the risks have slightly heightened in recent weeks. The optimism that the economy had at least stabilized appeared credible over the last few months, fostering hopes that the recession would soon conclude.
We maintain that viewpoint, although the transition from the end of economic contraction to substantial growth is likely to be lengthy and bumpy, as previously discussed, including here. However, the economic outlook remains fluid, and as new data emerges, strategic investors adjust their forecasts and asset allocations. This variability in anticipated risk premiums underscores the current market dynamics. Unfortunately, the latest outlook seems slightly less optimistic than it was in June; the challenges ahead appear more pronounced.
Creating solid forecasts of risk premiums based purely on historical data is insufficient; however, it does offer valuable insights into market fluctuations.
In light of this, we present an overview of recent history, particularly comparing the Global Market Index against several key asset classes since the late 1990s. (For a larger view, click on the chart.) While we’d like to showcase every corner of the capital and commodity markets, the chart would become overly complicated.
Nevertheless, this comparison provides an insight into how a diversified allocation across the world’s major asset classes (as defined by the GMI) performs against several typical benchmarks. As depicted, the GMI generally demonstrates moderate performance relative to its main components over time. This is why GMI, or a comparable measure, is recommended as a standard benchmark for all investors.
Does this imply that investors should never deviate from GMI’s allocation? Certainly not. Each investor should curate an asset allocation that aligns with their unique needs and expectations. However, strategic investors should only deviate from GMI with a well-reasoned basis. Achieving returns that beat GMI over the long term is challenging, especially considering risk adjustments, but it is achievable. Regardless of this goal, the initial step involves analyzing GMI and forming projections for each of its primary asset class components; a process that is generally complex and not conducive to rapid profitability. It’s no surprise that the finer aspects of multi-asset class investing often get overlooked.
Considering equities as a singular global beta is valid over extended time horizons. However, in the short term—potentially spanning 10 to 20 years—the rationale for differentiating geographically holds considerable weight. This is primarily because valuations and trailing returns differ significantly across global markets. Consequently, expected returns in these regions can vary, sometimes substantially.
Additionally, differing investor profiles—including risk tolerance, investment horizons, and financial situations—further support the case for adjusting global equity allocations over time to reflect an individual’s unique outlook.
Keeping this in mind, assessing recent performance across the primary equity regions worldwide provides insights into potential future developments, although we emphasize the term “potential.” We will explore these thoughts in greater detail in the upcoming July issue of The Beta Investment Report.
